Can I keep my job by just spending? Probably not just like that.
The Office for Budget
Responsibility, the Treasury’s official forecaster, warned that UK Gross
Domestic Product could fall by 35 per cent in the coming months due to the
coronavirus lockdown.
The world economy looks like it’s a on the brink of
recession.
Unemployment is on the rise, businesses temporarily shut as a
result of lockdown measures, some of which may not reopen anytime soon. Just as you are worried about the future of the economy, here are the Government’s plan to get the economy back up and running.
Government’s Role in a Recession – The Built-in Stabiliser.
An in-built stabiliser is “any aspect of government taxation
and expenditure policies that automatically reduces government expenditure
and/or increases government tax revenue when income and output are increasing,
or that automatically increases government expenditure and/or reduces
government tax revenue when income and output are falling”.
The most important
in-built stabilisers are taxes, income contributions NI and price supports.
Most economies (capitalist) have a comprehensive system of
unemployment trade-off financed by employer and employee contributions, which
are related to individual current income. In any recession, as unemployment
rises and employment incomes fall (just as we now see in the UK due to the
coronavirus pandemic), the amount paid out in unemployment benefit has increased
and the income obtained from contributions (National Income NI) has fallen.
The effect of unemployment
benefits in the UK is to reduce the decline in income experienced by the
unemployed, which allows them to maintain consumption than would have been
difficult if there was no income at all. The adverse effect on the economy from a fall in employment
is therefore reduced.
So will the built-in Stabiliser Be Enough?
In certain circumstances such as the current coronavirus pandemic, built-in
stabilisers may be unattractive. If an economy in an event of high unemployment
rate or high inflation, the effect of these built-in stabilisers may produce a
fiscal drag which is not what the economy needs right now.
We take fiscal drag as a factor that prevents the aggregate demand. An increase in taxes paid will reduce aggregate demand, 'if we pay more in taxes we are not encouraged to spend more on goods and services. Same applies to investors who will not be encouraged to invest as investment becomes less attractive.
Government Schemes to Support Businesses
In an attempt to prevent a recession due to the coronavirus pandemic,
the government knowing that the inbuilt stabilisers may not get the economy
back up blooming, they announced these measures
“Our Covid-19 support
schemes have provided over £15 billion for business in just a few weeks. We’ve
put in place:
-
our job
retention scheme - more than 500,000 claims have been made to the value of £4.5
billion
-
business
grants - half a million business properties have benefited from £6 billion of
business grants
-
the
Coronavirus Business Interruption Loan Scheme - with over 20,000 loans
-
the Covid
Corporate Financing Facility, which has provided over £14 billion for larger
firms
-
generous
VAT deferrals worth billions of pounds
-
scrapped
businesses rates
-
covering
the cost of statutory sick pay
-
the new
scheme will run alongside the existing Coronavirus Business Interruption Loan
Scheme (CBILS) and Coronavirus Large Business Interruption Loan Scheme (CLBILS)
We are also taking
additional steps on the Coronavirus Business Interruption Loan Scheme (CBILS)
to ensure that lenders have the confidence they need to process finance
applications quickly, including removing the per lender portfolio cap for the
government guarantee, and changing the viability tests that so that all banks
will need to assess is whether a business was viable pre COVID-19”
In addition to this, there is also the government backed
loan of up to 25,000 for new start-up businesses or those that have been trading for
up to 24 months.
The Role of the Bank of England during the Coronavirus Pandemic
The main duty of a central bank is to control the commercial
banks around it in such a way as to support the monetary policy of the economy.
It conducts its business activity by acting as the bankers’ bank and lender of
last resort, and also as a government’s bank and manager of the public debt.
By
doing this, the central bank is accountable for the conduct and process of
monetary policy that attempts to control the level of economic activity. That
involves regulating the supply of money and the cost and availability of
credit.
In this current circumstance, central bank is buying bonds.
The desired effect is to increase the supply of money and reduce the cost of
borrowing. As expected starting on April 7th, the UK government will
double the size of its corporate bond purchase program to at least 20 billion
pounds this is part of the stimulus package to help the economy during the
coronavirus crisis.
Open market operations influence the cost of borrowing as
well as the supply of money. If the central bank purchases bonds, the cash
reserves of the commercial banks rise and the commercial banks will wish to
lend more both to private customers and to business concerns.
This has led to a
reduction in interest rates which will make some investments profitable that
were previously unprofitable at the higher cost of borrowing. With a reduction
in the interest rates, the desired result is to make investments more
attractive due to low cost of borrowing.
With the current changes (the government schemes to support
businesses) in the availability and the cost of credit, this will influence the
level of aggregate demand. Aggregate demand is the total demand for final goods
and services in an economy.
Raising aggregate
demand, will lead to a multiple expansion in national income. This is the end
game for the government.
The Role of the Public to raise the Aggregate Demand
So if the sole purpose of the government is to increase
aggregate demand what does this translate to?
-
As aggregate demand increases, unemployment
reduces (firms will hire more to meet increase in goods and services)
-
As unemployment reduces, contribution increases
and benefits reduces
-
As contribution increases, income from tax
increases just like government income grows.
This is always the problem in any country; it’s like trying
to hit a target in a moving goal post. With all this policies in place, the
Government will be hoping that:
The public do not hold money either as bank
balance or at home. In the early stages of the lockdown / pandemic, a large
number of the public bought lots of foodstuff and this rush led to stores
having lesser products especially toilet rolls.
A customer who would normally
buy 4 packs of roll in a month goes on to buy more than 20 packs and keeping the
excess at home. Why would anyone buy more they need for a given month?
For
aggregate demand to rise, in other words for unemployment rate to reduce,
investment must rise, spending must rise and less money in the bank. With
government increasing supply of money, the expectation is that we will have to
spend our excess cash on goods and services and this will raise the aggregate
demand and as firms produce more, there is the need to hire more.
Investment
becomes more attractive and investors will borrow more money due to the lower
interest rates.
By now I can expect that we know how this works. So, everything
the government has done or plans to do, is to raise aggregate demand and
forecasting the reaction from investors and consumers to take up loans, spend
and invest.
Why would anyone store up excess tissue at
home? The likely answer is the same reason anyone would keep excess cash in
bank balances and not spend it. When interest rate is low, people put their money
elsewhere in assets that will yield a higher return like properties, shares,
buying or starting up businesses. But people will likely keep their excess in
the bank even though interest rate is low because of uncertainty.
The uncertainty about the lockdown and the
future as a result of the pandemic led to panic buying. The same reason that an
investor who is unsure about the future may be reluctant to take up new loans
even though interest rate is low. Uncertainty could be a reason to keep excess
cash in the bank even though interest rate is low.
Another factor that could affect government
plans in brexit. The uncertainty surrounding brexit may make businesses and
consumers hold money for speculative purposes. I may likely buy a new car as
soon as I get a chance if there’s a speculative of an hike in price of new
cars. I may also hold my excess cash if there’s speculation that a cost of a
commodity or stock/investment will fall in the future.
Finally, the coronavirus factor. In the
past few weeks businesses have been affected due to the pandemic. We have seen
lockdown around the world with businesses shut down temporarily.
What the
economy does not need is another wave of the pandemic. This may offset every
plan the government has put in place to increase employment. Also, some
businesses rely on exports to function.
Everything the government has done is
only a forecast but what we can do is be positive about the future.
We need
a collective action from everyone of us to get the economy to been productive
again. We are the government, the investors, sole traders and the consumers.
Every
decision we take will either have a positive or adverse effect on the economy.
Whilst I am not writing this to tell the public to go spend their savings, this
is just to tell the events that may bring back the economy up again.
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