Economics in China

   An important policy problem for governments is how to stimulate economic activity without causing inflation. The rise in inflation during boom times often leads policy-makers tighten their policy to bring inflation under control. When inflation falls after recession, policy-makers feel that they have the leeway to stimulate the economy again. Hence they have to tread carefully to achieve a suitable balance between stimulus and contraction and we will learn below that timing policy interventions in order to achieve a desired outcome is not a simple matter.

Interest rates

In addition to fiscal policy, government (or the monetary authority, where this is independent of government) has available the tools of monetary policy. Monetary policy involves changing interest rates, or the money supply, in order to influence the economy. High interest rates are a symptom of a tight monetary policy. When interest rates are high firms find it more costly to borrow, and this makes them more reluctant to invest in expanding their business. Individuals with mortgages or bank loans are also hit by high interest rates since it costs more to make their loan repayments. Hence high interest rates tend to reduce demand in the economy—firms invest less, and those with mortgages have less to spend. Low interest rates tend to stimulate demand. 

Unemployment

A downturn in economic activity causes an increase in unemployment. Indeed, it was the high unemployment of the 1930s that led to the establishment of the subject now known as macroeconomics, and unemployment is still a central concern of economics. During the Great Depression of the 1930s UK unemployment rose to nearly 20 per cent of the labour force, and even higher levels were reached in some other countries. Although in the 1950s and 1960s    unemployment was consistently very low in most industrial countries, higher unemployment returned in the 1980s and 1990s. UK unemployment¹ reached peaks of 12.2 per cent in 1986 and of 10.8 per cent in 1993 in the two recessions, while unemployment in France and Germany reached post' war highs of 12.5 and 11.7 per cent, respectively, in 1997. Japanese unemployment in June 2002 reached a level of 5.4 per cent, not seen there since the Second World War. By 2000 unemployment had fallen in Britain and the United States, but it was still relatively high in several European countries, such as Spain, Germany, and France (and it started to rise again in the United States in 2001/2). Accordingly, the analysis of the causes of, and potential cures for, unemployment is still very high on the agenda of macroeconomics today, especially in the EU and Japan. A new bout of high unemployment can never be ruled out, even for those countries where it has been low for some time.

   The main method of reducing unemployment that economists developed early in the twentieth century was for governments to increase their spending and reduce taxes. Such deliberate use of government spending and taxes to influence the economy is known as fiscal policy. In Chapter 33 we will discuss why this long accepted policy no longer seems promising. 

Government budget deficits

With the exception of two brief periods (1970 and 1988-9), the British government has had a budget deficit since the Second World War—it was spending more than it was raising in taxation. In the mid-1970s the budget deficit rose to around 8 per cent of the value of the nation's total annual output. In the early years of the twenty-first century the budget was again in deficit; and, with high government spending commitments, it seems likely to stay in deficit for the foreseeable future. Deficits have to be financed by government borrowing, which raises the national debt.

   At one time it was thought that budget deficit might be good for the economy because government spending created jobs. Nowadays there is more concern about the potential burden of the debt, in the form of interest, which has to be paid by taxpayers and which, therefore, keeps taxes high. In later chapters we will discuss how the budget deficit affects the economy, and the conflict over the role of the government budget that is central to macroeconomics. We will also discuss the implications of the limitations on budget deficits imposed on EU member states by the Maastricht Treaty and the Stability and Growth Pact.