UK Inflation and Unemployment

UK Inflation and Unemployment under New Labour

i) Pattern of unemployment and inflation over the past 10 years.

Since Labour came into power in 1997, unemployment has continued to plummet and inflation has been in line with its target rate every year since Gordon Brown set that target at 2%. There are numerous policies to combat both rises and falls in these two aspects of our financial system, and with their proportional relationship the government must find solutions to keep control of both major factors in our economy and keep them to a minimum.

The first graph illustrates the pattern of inflation from the 1990's to around 2005. You can see immediately the landmark at 1997 when Labour came into power. Gordon Brown and Tony Blair had the idea of providing employment opportunities for all, they attempted to avoid spending and taxation to alter the economy, but to get more of the British work force actually in full time employment, thus helping to reduce inflation. The graph shows that during the first stage (1992–1997) the actual rate of inflation tended to be above the mid-point of the 1%–4% range. Ever since the Bank of England, or Central Bank, was granted ‘independence' in 1997, the same occurred but only over very short periods of time. Most of the time during the latter period actual inflation has been nearer to the lower bound, clearly implying that monetary policy has been relatively tight.

The second explains the ‘growth' of the UK economy. In growth terms, gross domestic product (GDP) has grown at an average annual rate of 2.8% over the period 1997–2005. This can be compared with the previous 8 years where growth averaged1.9%, though over the period 1992–1997 growth averaged 3.1%. Closely examining these two aspects shows that growth has been relatively steady and since 1997 inflation has continued to fall and stay in line with the 1% tolerance rate above or below the target inflation rate.

This table, although dated long before Labours rise to power, shows the pattern of Labour Force unemployment. There is a high peak between 1991 and 1996, and then there is a significant fall. Labour have managed to bring employment opportunity to over 1.25 million people since 1997, they bought about the “flexible labour market” which allowed anybody to retrain to find alternative employment. They also enforced new legislation on who had the right to claim ‘dole' money and set up programs such as the “New Deal” for young persons (BBC News) and the new National Minimum wage scheme.

ii) Policies that the UK authorities implemented to tackle inflation and evaluation of success.

Essentially inflation refers to how much your money is worth; how much it can buy you one day compared to the next. What with the direct correlation between inflation and unemployment, the New Labour government were faced with the position of keeping inflation to a minimum.

At the moment the current target of inflation for the UK from the New Labour government is 2%. When a shift in demand or supply happens, obviously the government have to have policies in place to try and maintain a stable economy. Demand side changes means that the government have to rethink their spending and expenditure or that of the consumer, hopefully pushing aggregate demand down. They also adapt to a number of monetary policies. Gordon Brown in particular has the belief in “neutrality of money”, meaning that the central bank can actually no longer majorly affect the real economy by printing more and more money, so preventing loss of jobs, no effect on GDP and maintaining a steady level of investment. It means basically that any change made by the central bank will be matched with and equal rise or drop in price and wages. In May 1997, the inflation target was changed to 2.5% with a 1% tolerance range. The Retail Price Index (RPIX), excluding mortgage interest payments, was to be the new target. That was changed in December 2003 to the Harmonised Index of Consumer Prices

(HICP) with 2% being the central target and with a 1% tolerance range, this was declared by Gordon Brown in 2003.

The UK has met all inflation targets since Labour came to power in 1997, and looking 10 years ahead of that to 2007, inflation is still on target at 2%. Also interest rates are at the lowest they have been in the last forty years, bordering 4%. The Labour government are lucky because high levels of demand concerning consumption expenditure is what has driven the economic growth in the UK which means so far they have never had any real inflation problems to tackle. The main changes the Labour Government made started with institutional arrangements. The radical change gave the Bank of England independence to set interest rates, implying that it was no longer in the hands of any politicians and even the treasury would have no say in whether they could alter the rates. It was obviously given inflation rates to meet and it was the ‘Monetary Policy Committee's' job to maintain price stability by the use of these exact policies (Inflation and UK Monetary Policy – Mark Russell). Mention should obviously be made of the supportive fiscal framework. Tackling inflation and also carrying out monetary policy is only likely to be successful if it is accompanied by a prudent and sustainable set of fiscal plans. Fiscal policy has generally been set with an eye to the long term, leaving monetary policy to manage the economy in the short to medium term. Although the government can try to control the economy by altering the way it spends and taxes etc, it will only work alongside the appropriate monetary policies, effectively how the central bank decides to value its money (Begg, 2006).

A very imperative feature of the past decade has been the broad stability in the sterling-pound exchange rate. This degree of stability was unexpected because effectively replacing and exchange rate target with an inflation target seemed like it would cause a much more unstable outlook. The explanation may lie in part with the credibility of the monetary framework. The way that the Labour government aim to keep the exchange rate so successful is to look ahead; any change that can be foreseen can be matched in ratio with effective monetary policies, so any change in value of the money will result in more trade for instance, until the normal rate is resumed. The graph below illustrates this point. You can see clearly how over the last 10 years there has been almost no fluctuation at all in the value of the pound-sterling concerning exchange rate (National Statistic Online.

Lastly there is obviously the great influence of Globalisation on our economy. A lot of people would suggest that importing so much cheap material and goods is what helps this economy t stay so strong, but again, it is the strongly defined monetary policies that hold everything in place. Globalisation only represents a shock to relative prices and does not show the absolute price level. Any goods that are close substitutes for imports, their price will be driven down, but this may leave other goods to rise faster in value. It all depends on whether people react to their now “stronger purchasing power”. Spending less money on certain cheaper goods will just lead to a rise in their purchasing of other goods and services, leaving the balance relatively unchanged. The good sterling exchange rate means that there is never really any major fluctuation or drop in how people chose to spend their money.

Overall I think that the Labour government have been successful in keeping to their words and combating the problem of inflation, and consequently unemployment. New opportunities for people and a strong monetary backbone have made the economy stronger than ever, and even if Labour have drawn on the successes of the Keynesian era or even “Thatcherism”, according to what figures tell us, the methods in place are clearly working.

References

Mark Tran – What is unemployment

http://www.guardian.co.uk/world/2002/may/15/qanda.globalrecession

David Smith - “Ghosts of past inflation come back to haunt us”

http://www.economicsuk.com/blog/000336.html

“The economy of UK inflation creeps up”

http://news.bbc.co.uk/1/hi/business/the_economy/522530.stm

www.statistics.gov – Preliminary table.

“Economics” 8th Edition– David Begg

“Inflation and UK Monetary Policy” - Mark Russell and David HeathField

“The Labour Market under New Labour” Shackleton 2005

“Cambridge Online Journal”

journals.cambridge.org

“Bank Of England Online Discussion”

http://www.bankofengland.co.uk/publications/externalmpcpapers/index.htm

 

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