How Not to Run The British Economy

Running the British economy (into the ground)

After taking control of the economy in year 6 the economic climate seemed to be one of decline. Unemployment was at 6.47% and appeared to be increasing. Although growth had generally been good production (Y) have fallen to 446.75 with potential (q) at 450. Although inflation was reasonably high at 4.35 it did look like it was going down. However there had been an inflation warning thus inflationary pressure was a concern. I had decided to take a Keynesain approach to the problem of high unemployment rates and decreasing productivity by intervening to stimulate demand through government spending and a drop in tax rates. As we see on the basic circular flow model ( fig 1.1) an increase in governmental spending and a decrease in taxation should increase the flow of money both from the firms to the household, in terms of payments, and from the household to the firm in terms of consumption. It should therefore increase injections and decrease withdrawals. By doing this I hope to create ‘cumulative causation’. Basically, when I increase injections to industry by increasing government spending, they should increase their workforce or wages to deal with the extra demand, this should, in turn, increase the households income and therefore also increasing consumption and creating a positive circle of events. However, this should diminish as ‘leaks’ so the system in the form of imports, tax and savings will slow the growth. As people have more money, they may very well save more money, or import more things after all. I would, therefore hope to stimulate demand, increase productivity and lower unemployment. However, a decrease in unemployment has been linked to an increase in inflation. The ‘Philips curve’ shows a clear correlation between unemployment and inflation (see figure 1.2). As we see from the Philips curve there may be inflationary pressure if unemployment decreases ( as is the plan). Although the clear Philips curve has broken down, deviations of it still exist and the principle is still important. As Aggregate demand increase, unemployment falls, people have more money and therefore the value of money falls. In an effort to counter balance this potential problem I have also decided to decrease the supply of money. As more modern traditional economist such as Friedman have linked inflation to money supply and inflation represents a decrease in the value of money, a decrease in the supply of money should increase it’s value and maintain inflation at lower levels. Given all these factors I have decided to increase government spending by 3, decrease tax by 3 and decrease money supply by 1.
In year 7 unemployment continues to rise to 7.09 inflation rate to 7.56 however production did rise to 454.11. Although these would appear to be fairly negative results, I did not want to fall in the trap of being over reactionary. As my policy changes had only one year to function, another increase in government spending may have lead to an increase in Aggregate demand beyond that of capacity, giving rise to serious inflationary pressure issues. Given these concerns, and a belief that my policies would begin to function I made no changes. This paid off effectively in year 8 which saw decreases in Unemployment, and increases in growth. It also saw decreases in Inflation. Although it would my original prediction that inflation would be caused by an increase in output, if production is below capacity, then demand pull inflation is not likely (figure 1.3). My decrease in the money supply should also have had a possible effect on inflation. However, given the possibility that aggregate demand may be over stimulated and lead to an increase in demand pull inflationary pressure I decided to, again, decrease the money supply. However, as I was concerned about the effect on a decrease on the supply of money on growth rates I chose simply to reduce money supply by one.

In year nine, Owing to dramatic cuts in investment that were beyond my control ,unemployment has risen to 10.59% and productivity is down to 449.3/486.5. The budget was also unbalanced at -21.4 and the trade balance was significantly down. As we see on the circular flow diagram a decrease in foreign investment represents a decrease in injections into the economy, this is likely to cause negative cumulative causations causing a possible recession, as both demand and supply downwardly circle. It was, therefore important to stimulate growth. As previously stated an increase in growth could potentially cause an increase in inflation. However, as inflation is relatively low and the economy is running below capacity this seems like a small threat. Therefore I decided to take drastic actions raising governmental spending by 4 and dropping tax by 4. Again, hoping to stimulate demand. Increases in Government Debit, raised concerns about the balance of payments, and general concerns about spiralling liabilities. However, although I was concerned about this, I felt that growth was a more important aim at this time.
By year 10 it would seems that my dramatic increases in governmental spending have lead to only a minor increase in productivity. This would appear to be linked to some major problems in the economy. Unemployment is quite high and government budget deficit and balance of trade are all concerning negative. I suspect that these factors as related, as the finance necessary to fund the large budget deficit may be borrowed from abroad. The instability of a heavily in debt state may well also discourage foreign investment. As inflation has dropped to minus levels, as government borrowing is so high I have decided to increase VAT by 2%. As VAT effects the price of goods, it should increase the average cost of goods, therefore the consumer price index and inflation. This should help to stabilise out inflation. Although the cost of inflation may not be instantly clear, it causes ‘menu’ costs (ie the costs of changing prices for goods) and also creates instability and therefore people would be less likely to invest. Negative inflation rates are, therefore, just as damaging as positive levels and therefore I hope to level out inflation rates whilst hoping to balance to budget a little.
By year 11 Inflation has moved closer to zero and the budget situation Ha improved. Given the need to seriously do something about the budget deficit. In line with current events tax rates have been increase by 4% dealing mainly with my budget problem. However, again if we refer to the circular flow model, this represents a withdrawal from the economy. Therefore there would be an expected decrease in Aggregate demand and possibly serious consequences for growth. I have therefore, increase government spending by 4% and vat by 2%. Both in order to stabilise inflation and increase growth. In year 12 Given the need for the budget to improve I took no action.

In year 13 I felt that my previous polices had not been effective. Given the serious state of growth, and the poor state of unemployment I decided upon a 4% increase in governmental spending and a 4% reduction in taxation.
Again, despite the budget deficit I felt that the need for growth was overwhelming. As inflation was still relatively low and the economy well below capacity I felt that inflation was unlikely. After a period of economic growth I hoped to increase taxation to deal with the budget deficit. In year 14 my policies appeared to have reaped significant economic growth, therefore I made no changes
The economy was again growing strongly in year 15. After being told disturbing news that the government was unlikely to be re-elected, I decided to make significant government expenditure and tax cuts to attempt to acquire short-term economic growth and increase the potential of being re-elected. Hopefully the electorate will believe that the government has skilfully guided the economy through difficult times and that the short- term economic growth will continue. I also hope that this stimulation of demand will genuinely help the economy reach capacity again.
My final year in office saw increases in productivity and decrease in unemployment. The economy seemed to be on the way up, and no doubt the budget deficit could be dealt with when the economy surpassed capacity. To review my running of the economy, I felt that I have been high successful in controlling inflation, by the supply of money and the use of VAT. Inflationary pressure was never on issues, although that may have been partly due to poor economic growth. I feel that I correctly used expansionary governmental policy and tax cuts to attempt to stimulate the economy, although I am not convinced that the right amount of spending at the right time was used. Sometimes greater spending may have been necessary. However, it is quite possible that classical economists are indeed correct and that expansionary policy leads to no long term benefits.
My problems with Government deficit of some degree of concern, although I’m not sure if they were pivotal. It is indeed possible that too much money was spent at inappropriate times, or that sometimes my primary goal of dealing with inflation over-shadowed my other economic aims ( I should have worked for Thatcher). The biggest fundamental error I feel that I made was to underestimate the value of the balance of trade. My attempts to reduce inflation by increasing VAT will have increased the price of goods relative to foreign goods and therefore increase outflows from the economy. I feel that management of the balance of trade via the use of VAT would have significantly improved my economic performance.

Economics, Sloman John Pearson education Limited 1991 http://www.bized.ac.uk/learn/economics/macro/index.htm http://william-king.www.drexel.edu/top/prin/txt/Intro/Ch1ToC.html http://www.marxist.com/Economy/brit_economy0304.html http://www.ingrimayne.com/econ/EconomicCatastrophe/OverviewA6.html