Contemporary Economic Issues

Subject: Politics
Type: Informative Essay
Pages: 5
Word count: 1371
Topics: Public Policy, Accounting, Finance, Government, Macroeconomics
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In the eyes of Wren-Lewis, the government’s pursuit of austerity in 2010 delayed the economic recovery and might have cost the UK 5% of GDP or an equivalent of £1500 per person. Wren-Lewis believes the coalition’s decision regarding austerity was unnecessary and unwarranted as it gave rise to lower growth which in turn resulted to delayed rises in tax increments. In addition, the austerity was uncalled for because interest rates stood at 0% while demand for government bonds shot high. However, Wren-Lewis deliberates that delaying budgetary changes up until the recovery process strengthened could have averted the double dip downtown and still foster the government to reduce debt to GDP in the long run (Calmfors and Wren‐Lewis, 2011:649). Wren-Lewis argues that the UK’s delayed recovery over the larger part of the coalition government’s term was correlational to the government’s fiscal decisions. As such, it will take many years before economists can settle on a number or figure that can best measure up the cost of that mistake.

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When the Labor government assumed power in 1997, the Bank of England was made independent. In addition, it introduced a new stature or framework for aggregate fiscal policies. Although most macroeconomists viewed these changes as progressive, Wren-Lewis argues that the transparency and fiscal rules that came along with the changes were practically close to best. In the same vein, when the Coalition government assumed power in 2010, it set forth critical institutional reforms as well; creation of the Office of Budget Responsibility (Wren-Lewis, 2013:25). The backdrop of Wren-Lewis’ claim is based on the fact that the Coalition government made the fiscal decisions at a time when the interest rates were at ‘Zero Lower Bound’ (ZLB): 0.5%. In essence, getting the economy back on track must have taken time and formulation strategies that would kick start it back to its previous level such as that of 1997 when the interest rate was above 6%.

The delay illustrated by Wren-Lewis in his statement was conceived by the government’s inability to counter the deflationary force brought about by the Coalition government’s policy on sharp fiscal consolidation (Wren-Lewis, 2013:31). Irrespective of the fact that fiscal austerity was put on hold to some extent in 2012, the damage had already been done. From a conservative’s point of view, it is estimated that about 5% of the country’s GDP was already lost permanently following that mistake which in turn produced the least recovery ever recorded in the UK. While basing his arguments on the Keynesian perspective, Wren-Lewis points out that the delay followed the large government deficits which prompted the OBR to introduce a counteractive hedge that would increase private sector saving. With the increased government debt, it was possible for the private sector to save as the situation provided the latter with the additional financial assets required for private sector saving.

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According to Wren-Lewis, the 2010 fiscal policy delayed in the UK since it switched from supporting demand in the Keynesian way to focusing on deficit reduction. In fact, the delay was imminent as this change of focus was not going to affect the UK alone but also the Eurozone where a crisis of its own was looming and spreading rapidly to other countries. The switch from fiscal stimulus advocacy in 2009 to austerity in 2010 dwindled the Coalition government’s quest for spontaneous growth. In addition, the OBR thought that austerity would reduce demand and foster active monetary policy just as it the case with the New Keynesian models. However, this aspect backfired and ended up being a costly affair for the Coalition government. Note that, the Coalition government’s fiscal mandate would have worked positively were they to be implemented in normal times (Calmfors and Wren‐Lewis, 2011:654).

The tragedy for the UK economy as well as the Coalition government was enacting the fiscal policies at a time when interest rates stuck at ZLB. In effect, it was mistaken to target current balance instead of the deficit thus it excluded public investment. Nonetheless, it is crucial to note that this aspect presented the Coalition government with the opportunity to keep public investment high in order to support the recovery but unfortunately, the Coalition did not uptake it but instead cut public investment sharply. This, in return, led to the delay Wren-Lewis discussed in detail. The introduction of fiscal austerity at a time when interest rates had plummeted to their all-time low was knowingly going to delay recovery. The forecast outlined by OBR in 2010 sounded too optimistic which meant that the monetary policy was going to rely untested and unconventional tools such as Quantitative Easing (QE) in order to see the recovery process back on track (Wren-Lewis, 2013:45).

Since inflation rose sharply in 2011, it is counter-argued that there could have been no positive impacts on GDP. Nonetheless, this argument should not be used as an excuse for this mistake as heightened inflation was not forecasted in 2010. A cumulative GDP loss of 5% might be lower than the resources wasted following the adoption of austerity. With a sharp rise in inflation, a delay was inevitable in the first part of the Coalition government (Heald and Georgiou, 2011:217). In particular, the economy was not going to start growing at once upon the OBR’s adoption of austerity measures and as such, the mistake could not have been averted the moment austerity measures were set in place.

Is the case for expanding public investment as strong now as it was in 2010?

Economies tend to keep on growing unless they keep being hit by adverse conditions and shocks. As of today, the case of expanding public investment is stronger than it was in 2010. In actual understanding, the proponents of fiscality fail to explain why the recovery process of the UK strengthened gradually over the last 6 months given that the pace of fiscal consolidation is still at its usual rate while the government cuts are progressing just as planned. Normalizing economic activities after austerity was going to be tough but expanding public investment grew stronger as from 2010 (Buisson, 2013:59). Indeed, the government’s change of course and reduced structural pace of consolidation predicted stronger growth just as analyzed by the proponents of fiscality.

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It is difficult to understand why the austerity mistake was made given that the IMF was opposed to it in 2009. Recovering an economic depression for the UK was not an easy task and investment was cut back greatly in the first two years of the Coalition government. It is unrealistic as to why the Chancellor was proposing an extended period of austerity after 2015 irrespective of the fact that interest rates still remain at the ZLB. The case for expanding public investment is today debatable, especially when compared with the way it was in 2010 (Heald and Georgiou, 2011:233). Generally, the case for expanding public investment is strong now as it was in 2010 following reduced borrowing and filled the gap of debts.

In conclusion, the Coalition government presented two paramount fiscal policy innovations that could be viewed as progressive. For one, establishing the OBR and the subsequent adoption of a primary fiscal mandate that would have been a suitable framework were it enrolled in normal times. Tragedy struck when the Coalition and the UK economy were mandated to implement a sharp fiscal contraction at a time when it should not have been as interest rates had sunk to their ZLB.  In view of mainstream macroeconomic analysts, the panicking that was created by the Eurozone crisis led to the unwarranted delay. Upon analyzing the state of economy since the Great Recession, it can be deduced that the delay in the UK recovery that was experienced in the first part of the Coalition resulted from the government’s fiscal decisions (Buisson, 2013:62). In the paper, I have argued that these decisions were uncalled for, unwarranted and resulted in a mistake that cost the UK immensely. In effect, it will take the UK many years to settle on a figure that can best describe the much the government has lost following this mistake. It will also prove to be time-consuming to measure the influence of welfare to citizens with respect to making fiscal decisions in a time of peace. The case for expanding public investment is not as strong now as it was in 2010 and this has been deliberated by the foreseeable changes in the effects of the fiscal decisions made by the Coalition government.

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  1. Buisson, A. 2013. From PFI to PF2: The reform of the public private partnership model in the UK. London: Norton Rose Fulbright LLP.
  2. Calmfors, L. and Wren‐Lewis, S. 2011. ‘What should fiscal councils do?’ Economic Policy, vol. 26(68), pages 649-695.
  3. Heald, D. and Georgiou, G. 2011. The substance of accounting for public-private partnerships’, Financial Accountability & Management, Vol.27 (2), pp.217-247.
  4. Wren-Lewis, S. 2013. ‘Aggregate fiscal policy under the Labour government, 1997–2010’, Oxford Review of Economic Policy,, vol. 29(1), pages 25-46, SPRING.
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