Times of economic uncertainty need policies that bring stability

Economic fluctuations are present in all walks of life. Every country faces economic changes which affect mainly three areas namely growth, stability and distribution patterns in the economy. These three areas have always been the major source of attention for government officials.

Growth can be defined as an increase in real national income in the country.  Stability is the absence of fluctuations in the income, price, and unemployment levels in the economy. Distribution comprises of dissemination of income among various household present in the economy. Economic fluctuations exist and uncertainty prevails in the economic system. Therefore, the government tries to reduce the risk and uncertainty by making various stabilisation policies.

 Stabilisation policy is a set of measures undertaken by the government to stabilise the financial system in the economy. It also refers to correcting the normal behaviour of the business cycle in the economy. Stabilization policies or economic policies are undertaken by government to control fluctuations in business cycles and prevent high rate of inflation and unemployment that can prevail in the economy.

These policies are also known as counter-cyclical because they counter the ups and downs of the business cycle. There are mainly three types of policies that are used to control economic fluctuations and tries to maintain price stability and helps in attaining a level of economic growth in the economy.

Monetary policy

 The three types of policies are monetary policy, fiscal policy and direct control. The most common policy framed by the government for solving the problems of economic fluctuations is monetary policy. It is related to banking systems like credit given by banks and the availability of loans to individuals and households. It also covers the management of interest rates, public debt, and monetary management in the economy.

The biggest problem with monetary policy is to control and regulate the volume of credit in the economy to maintain a proper level of growth and stability in the economy. During the phase of economic depression, credit must be expanded. During an economic boom, credit flow should be restricted. Monetary management affects the cash flows of the firm because it helps in regulating the supply of money and credit in the economy by influencing the interest rates and availability of credit in the economy.

Currently, the residents of United Kingdom are suffering due to the rising cost of living and shooting energy prices as winter approaches. Additionally, Chancellor of Exchequer Kwasi Kwarteng has in the mini-budget shaken the economy further. Bank of England senior official Huw Mill warns “significant increases in interest rates will have to be imposed by the Bank of England in response to tax cuts put forward by Kwasi Kwarteng in his mini-budget.

“The increase in interest rates has caused turmoil with borrowers being “reduced to tears” over mortgages. On 28th September 2022, The Bank of England triggered headlines as they “stepped into Britain's bond market pledging to buy around 65 billion pounds of long-dated gilts after the new government's tax cut plans sparked the biggest sell-off in decades.”  The economy is facing tremendous challenges due to this abrupt instruction and this is where clearly thought-out stabilization policies are required.

 With monetary policies, when bank credit has expanded the flow of expenditure increases and when bank credit has contracted, the flow of expenditure reduces in the economic system.

There are two types of monetary policies; expansionary and contractionary. There are various quantitative and qualitative measures undertaken to control the credit-creating activity of the banking system. Bank rate or discount rate is the rate of interest which central bank charges on the loans and advances given to a commercial bank.

Shortage of funds

When a commercial bank has a shortage of funds they can borrow money from the central bank. Borrowing of money by commercial banks will be through repo-rate. If repo-rate is reduced the bank will get credit at a cheaper rate and if it is increased then the commercial bank will have to borrow loans at expensive rates. Fixation of bank rate is done to control inflation and to maintain stability in the economy.

The reserve ratio is the percentage of deposits that the commercial banks have to keep in cash according to the instructions of the Central Bank. When Central Bank wants to increase the money supply it will lower the reserve ratio and when the bank wants to decrease the money supply it will increase the reserve ratio. It serves as a very important tool for controlling inflation and monetary policy.

Selective control means regulating the flow of credit for a particular purpose. The concept of selective control was opted by the USA to regulate the flow of credit to the stock market. In countries where speculative trading takes place such as in India through their stock exchanges, this tool can be most useful, especially for regulating the price of grain, sugar, cotton, and keeping a check on the rise in prices of agricultural produces. In Kenya, the cost of living has become a challenge for the wananchi. Policymakers must use stabilisation policies to immediately stabilise and reduce the price of fuel and food.

Economic fiscal policies

 Economic fiscal policies relate to the tax and expenditure policy of the government. Economist A.Smities defined it as “a policy under which the government uses its expenditure and revenue programs to produce desirable effects and avoid undesirable effects on the national income, production, and employment.”

Fiscal policy is being operated through the control of government expenditures, and tax receipts. This policy relates to keep a check and strict control on private spending. It also deals with various channels by which government spending on new goods and services entering in the economy can directly add in aggregate demand, and indirectly addition in the income of the government through the concept of the multiplier effect. For effective working of the fiscal policy, it should be planned carefully keeping in view short and long-term plans.

 How about employment? GLS Shackles highlighted that “Uncertainty is the very bedrock of Keynes's theory of employment.” The concept of uncertainty was given by Keynes, but the concept was later used by James Tobin in 1970. According to Keynes uncertainty refers to a situation in which knowledge confirming the future effects of a current action does not, and cannot exist. Thus uncertainty reflects a lack of knowledge or probabilities for future outlook is unknown. Each and every person is being affected due to uncertainty, whether individuals, investors, government, businessmen, or policymakers. Individuals expect a higher income in the future. Investors expect higher dividends. Companies expect greater profitability.

Can it be said that expectations give rise to uncertainty? Policymakers have a critical role to play here. We need policymakers to understand the ripple effects of each action and stabilize the economy in favour of the citizen's and stakeholders' wellbeing, growth, and overall progress of the economy, the current immediate need being the reduction of cost of living.

Ritesh Barot is a business and financial analyst, [email protected]