Sticky wages

Definition – Sticky wages is a concept to describe how in the real world, wages may be slow to change and get stuck above the equilibrium because workers resist nominal wage cuts. Wages can be ‘sticky’ for numerous reasons including – the role of trade unions, employment contracts, reluctance to accept nominal wage cuts and …

Read moreSticky wages

Main Problems of UK Economy

uk-car-production

Readers Question: What are the main problems of the current UK economic situation? Low economic growth and in particular stagnant real wage growth Poor productivity growth since 2008 – which affects long-term growth prospects. Uncertainty from Brexit and likely costs to trade from new custom arrangements. Manufacturing sector State of the housing market – expensive …

Read moreMain Problems of UK Economy

The importance of elasticity of supply

elasticity-of-supply-effect-demand

The elasticity of supply measures the responsiveness of a change in quantity supplied to a change in price. If price increases – firms generally find it more profitable to supply a good. So an increase in price leads to higher supply. However, if it is difficult to increase supply (e.g. shortage of capacity, difficulty to …

Read moreThe importance of elasticity of supply

Problems of deflation

deflation-inflation-20s-30s

Deflation is defined as a fall in the general price level. It is a negative rate of inflation. The problem with deflation is that often it can contribute to lower economic growth. This is because deflation increases the real value of debt – and therefore reducing the spending power of firms and consumers. Also, falling …

Read moreProblems of deflation

Pros and Cons of Inequality

inequality-pros-cons

Readers Question: ‘Society may come to the view that too much inequality is unacceptable or undesirable’  Assess whether inequality can cause economic problems, such as market failure. What are the advantages and disadvantages of inequality? Inequality means there is a gap between the highest income earners and the lowest income earners. (inequality can also relate …

Read morePros and Cons of Inequality

The Role of Supply Side Policies in a Recession

Supply side policies are efforts to increase competitiveness and efficiency in the economy. They can include policies such as tax cuts, privatisation, investment in education and more flexible labour markets. Usually, supply side policies are long-term efforts to increase productivity and the long-run trend rate of growth. The traditional solution to a recession is to …

Read moreThe Role of Supply Side Policies in a Recession

Policies for Economic Growth

policies-for-economic-growth

Government policies to increase economic growth are focused on trying to increase aggregate demand (demand side policies) or increase aggregate supply/productivity (supply side policies)

  • Demand side policies include:
    • Fiscal policy (cutting taxes/increasing government spending)
    • Monetary policy (cutting interest rates)
  • Supply side policies include:
    • Privatisation, deregulation, tax cuts, free trade agreements (free market supply side policies)
    • Improved education and training, improved infrastructure. (interventionist supply side policies)

Demand side policies are important during a recession or period of economic stagnation. Supply side policies are relevant for improving the long run growth in productivity.

policies-for-economic-growth

Demand side policies

Demand side policies aim to increase aggregate demand (AD). This needs to be done during a recession or a period of below-trend growth. If there is spare capacity (negative output gap) then demand-side policies can play a role in increasing the rate of economic growth. However, if the economy is already close to full capacity (trend rate of growth) a further increase in AD will mainly cause inflation.
ad-increase

In this case, the economy at Y1 has spare capacity. Therefore an increase in AD leads to a rise in real GDP.

Monetary Policy

Monetary policy is the most common tool for influencing economic activity. To boost AD, the Central Bank (or government) can cut interest rates. Lower interest rates reduce the cost of borrowing, encouraging investment and consumer spending. Lower interest rates also reduce the incentive to save, making spending more attractive instead. Lower interest rates will also reduce mortgage interest payments, increasing disposable income for consumers.

econ-growth

In 2009, base rates were cut to 0.5% to try and stimulate economic growth in the UK.

More detail on the effect of lower interest rates.

Evaluation of Monetary Policy

Lower interest rates may not always boost spending. In a liquidity trap, lower interest rates may not increase spending because people are trying to pay back debts. In 2009, UK interest rates were cut to 0.5%, but spending remained subdued. Banks were unwilling to lend because of liquidity shortages. Therefore, although in theory, it was cheap to borrow, it was hard to actually create credit. Therefore, this shows monetary policy can be ineffective in boosting economic growth

Another criticism of monetary policy is that cutting interest rates very low could distort future economic activity. For example, the US cut interest rates following the economic uncertainty of 9/11. These low-interest rates encouraged people to take on ambitious loans and mortgages; this was a factor behind the US housing bubble. Therefore cutting interest rates, at the wrong time, can contribute to a future housing and asset bubble which will destabilise economic growth. However, in 2009-12, the depth of the financial crisis means there is no immediate danger of a housing bubble, so it was appropriate to keep interest rates at zero.

2. Quantitative Easing

In a liquidity trap, where lower interest rates fail to boost demand, the Central Bank may need to pursue more unconventional types of monetary policy. Quantitative easing involves increasing the money supply and buying bonds to keep bond rates low. The hope is that the increase in the money supply and lower interest rates will boost investment and economic activity. The fear is that increasing the money supply could cause inflation. Though evidence from 2009-12 suggests that the inflationary impact was minimal. Without quantitative easing, the recession was likely to be deeper, though QE alone failed to return the economy back to a normal growth projection.

Read morePolicies for Economic Growth

Why is organic food so expensive?

Organic food is increasingly popular. In the UK, sales of organic food and drink is worth £1.96bn. But organic food still has only 1.4% share of the food and drink market (Soil Association) – with higher prices discouraging many shoppers. Organic food also attracts a hefty premium over non-organic food. In 2016, in the US, …

Read moreWhy is organic food so expensive?

Item added to cart.
0 items - £0.00