Should the government focusing more on having high Aggregate Demand or maintaining low

inflation rate? This is the main question by most economics scholars around the world especially
when discussing about policies for country especially in the last century. This later induces the
emergence and development of macroeconomics’ theories that are used by the governments
globally. This essay will discuss the reasons and effects of most of macroeconomic events from 1950
to 2007 in United Kingdom (UK) and would give some evaluation on the significance of the
development in macroeconomic theory toward the key events throughout the period.

This essay will be separated into 2 main divisions. The first division will be explaining about three
major periods throughout 1950 till 2007 and discussing the arguments and issues of the
macroeconomic theory used toward the key macroeconomic events in UK. Next, this essay will
critically evaluate the reason on the development of the macroeconomic theories and the link to the
macroeconomics’ data and crisis.

Graph 1 : Composite measures of real UK GDP %: annual growth (1950-2007). Source, http://www.bankofengland.co.uk/research/Pages/onebank/threecenturies.aspx

Graph 2 : UK Consumer price inflation % (1950-2007). Source, http://www.bankofengland.co.uk/research/Pages/onebank/threecenturies.aspx

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Graph 3: Unemployment rate (ILO/LFS) in UK (1950-2007). Source, http://www.bankofengland.co.uk/research/Pages/onebank/threecenturies.aspx

The first major period that is going to be discussed is from 1950 to 1974. During this period, the UK
government had adopted ‘Keynesian Revolution’ macroeconomics’ theory as a basis for making their
policies. Keynesian focussing more on influencing economy through boosting and contracting
aggregate demand in the economy by the intervention of government which later “both
Conservative and Labour pursued Keynesian demand-management policies” to sustain the economy
(pp.485, Sloman, Wride and Garratt, 2012). Based on graph 1, we can see that the real UK Growth
Domestic Product has fluctuated throughout the duration which implies that the government had
endorsed a stop-go policy to counterbalance the effect of business cycle. This government policy has
provided a rather low inflation rate averaged around 3.9% based on graph 2 and keeping the
unemployment rate lower than 2% until the end of 1960s.

The Keynesian policy started to show its flaw from the 1970s when the Barber’s expansionary
measures in 1972 started to cause a stagflation in the economy. This failure was mainly due to the
excessive loosening action and deteriorated with the OPEC crisis in 1973. The Conservative
government had planned to have a modest deflation but suspended when they lose power to
Labour and eventually ended the era of Keynesian policy. (389-390, Floud and Johnson, 2004)

The second major period is from 1975 to 1990 which the Labour government started to be more
influenced by Monetarist theory. This macroeconomics’ theory concentrated more on the historical
tie between money supply and prices. Monetarist infers that inflation was ‘always and everywhere a
monetary phenomenon’ (pp.486, Sloman, Wride and Garratt, 2012). “The Thatcherite anti-
inflationary has proposed the budget in the year 1979 to set out the ‘medium term financial
strategy’ (MTFS), which suggested a path of reduction in the cash deficit (the public sector
borrowing requirement) as a share of GDP” (pp.391, Floud and Johnson, 2004). From graph 2, we
can see the effect of the Thatcher’s government policy which shows that the inflation rate started
pushing downward during 1980s as well as the UK real GDP in 1980s. The impact of the policy has
also demonstrated the increased reliance on the market, privatisation and deregulation, curb of
union power, and less control over financial system (pp.487, Sloman, Wride and Garratt, 2012).

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Despite its success in forcing the price inflation to keep low, the government has been criticised for
the continuation of high unemployment although when the economy was in booming era. Keynesian
scholars critiqued this problem as they believe that there are structural problems due to
privatisation and hysteresis that did not really been considered into the monetarist policy (pp.488,
Sloman, Wride and Garratt, 2012).

The final major period to be discussed is from 1990 to 2007. This period is considered to be the
growth of “mainstream consensus”. Based on graph 1, we can see that the fluctuations of real UK
GDP was under control and both inflation and unemployment rate has shown downward trend
throughout the duration. Starting from the 1990s, the focus of economy has shifted towards
promoting a more conducive economic environment for long-term economic growth and prosperity.
Technological progress and long-term growth has been the main discussion by most policy makers
and resulted in holistic economic growth. (pp.490, Sloman, Wride and Garratt, 2012)

Over this period, the policy makers and politicians have also discussed about limiting the reliance of
market and the intervention of government in the economy. Based on the insights of previous
macroeconomics’ policies, the government has introduced ‘constrained discretion’ which limit the
usage of fiscal policy. In fact, it was suggested that new form of demand management is introduced
that affects the growth in nominal spending by changing interest rate. This to make sure that the
independent Bank of England meets the inflation rate target. (pp.490, Sloman, Wride and Garratt,
2012)

The Keynesian Revolution in UK was due to the huge flaws of failing Classical Macroeconomics’
theory especially after Great depression and World War 2. The focus of Keynesian on increasing
Aggregate Demand and favouring government to intervene in the economy has shown some great
impact on lowering inflation rate and keeping unemployment rate small. However, the flaw of
Keynesian revealed when there was excessive budget deficit and huge debt in the government due
to high cost of the fiscal policy. The crowding out phenomenon together with external factor such as
OPEC crisis has worsened the situation when stagflation started to take over the economy. This was
when a new macroeconomics’ theory such as monetarist policy seen to be as a saviour to the
unresolved crisis. The main ideas of monetarists to keep the inflation low and promoting reliance to
free market did give some good recovery to the economy. However, all theories have their own
flaws. Monetarists have been criticised on the abandonment of great increase in the unemployment
and highly reliable to the inefficient free market system. The problem of time lags did hurt the
effectiveness of the policy which later leads to the emergence of ‘mainstream consensus’ era which
learned from flaws of the previous macroeconomics’ theories.

In conclusion, the developments of macroeconomics’ theories are the result of the unsettled crisis
and flaws of the previous policies. Despite of all the failures, most macroeconomics’ theories have
proved that they did work into certain extent as explained throughout the essay. The new upcoming
macroeconomic theory might be more complex considering new political, technology and economic
challenges. However, the insights from all previous macroeconomics’ theories’ success and failures
will be a great foundation for settling new global crisis.

Words: 1082

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Reference

 Floud, R. and Johnson, P. (2004). Cambridge Economic History of Modern Britain. 1st ed.
Cambridge: Cambridge University Press.
 Sloman, J., Wride, A. and Garratt, D. (2012). Economics. 1st ed. Harlow, England: Pearson.
 Bankofengland.co.uk. (2017). Three centuries of macroeconomic data | Bank of England.
[online] Available at:
http://www.bankofengland.co.uk/research/Pages/onebank/threecenturies.aspx [Accessed
28 Mar. 2017].

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