Government Role Behind Hike in Oil Prices in Middle East

Question 1- Oil prices have risen temporarily due to political uncertainty in the Middle East. An advisor suggests, Higher oil prices reduce aggregate supply. To offset this we must increase the money supply. Then the price level wont need to adjust to restore equilibrium,and well prevent a recession, Using your knowledge of the macroeconomic policy,comment on the effectiveness of the above statement? Answer - In the Middle East there has been a temporary increase in the oil prices due to various political uncertainties. It is suggested by an advisor that the aggregate demand in the economy can be reduced significantly due to the higher oil process and thus it is very important to offset the impact of such a rise in the oil price that affects the aggregate demand. Thus it is suggested by the advisor to increase the money supply in the economy. It is expected that the measure will be very effective and the price level will not have to be adjusted for restoring the equilibrium and it will also prevent the recession (Krugman and Wells, 2013). Here the market of aggregate demand and the aggregate supply and IS-LM model can be considered as well for analysing the statement. The aggregate demand-aggregate supply (AD-AS) model basically uses the aggregate demand and supply in the economy in order to explain the relationship between the output and the price level in the economy. In terms of IS-LM equilibrium it can be said that the aggregate demand is the income at different price levels. The AD curve is usually downward sloping and it represents the equilibrium in the goods market. It represents various combinations of output and price level (Hubbard and O'Brien, 2013). On the other hand the aggregate supply curve shown factor market equilibrium and it represents how much output will be supplied by the producers at different price level. In this case it is stated that the policy will affect aggregate demand in the economy offsetting the negative impact for avoiding recession. But the statement is not correct as it will affect on the Full employment of FE line but not the aggregate demand (Hubbard and O'Brien, 2013). So it can be said that the policy is not correct. Money supply increase may also increase the inflation level even higher thus money supply should be reduced instead of increasing in the economy. This will increase the real interest rate and the output level will fall. This can be explained with the help of the following diagram. In the above diagram it is seen that, when the real money supply increases, it does not shift the FE or IS line and the rate of interest and the income remains the same. The increase in the real money supply will shift the LM curve rightwards and the rate of interest will fall and the income will increase. Here the FE or the labour market equilibrate slowly where the asset market adjusts faster, the goods market adjusts moderately (Mankiw, 2013). Thus it will be more effective to lower the real money supply in the economy as it can help in lowering the aggregate demand. This will shift the LM curve to the left and thus the output level can fall and the real interest rate will rise. This will lead to a reduction in the price level and the recession can be avoided in the economy. So the policy measure suggested here is not effective. Question 2 - It is a role of every government to smooth the business cycles that may emanate from the global market. Try to examine measures taken by the UKs coalition government in trying to ensure that the economy benefits every citizen and reduces overall burden of it(QE, Fiscal policy, Monetary policy, Multiplier effect)? Answer - It is known that business cycles can create various issues in the economy and thus it is the responsibility of each and every government to smooth the business cycle that may emanate from the global market. The coalition government has taken various measures in order to ensure that every citizen is benefitted in the economy and to reduce the overall burden. There are various policies that are taken by the coalition government in the UK in order to increase the efficiency in the economy. The fiscal policy basically involves government borrowings, taxation, government expenditure etc. fiscal policy can change the aggregate demand and supply in the economy (Painter, 2012). A growth review has been launched by the coalition government in the UK. The government has also increased the transfer payments in the economy in order to increase the welfare of people. There are social and economic justifications are also given for merit goods and the public goods for increasing the welfare (Hoxley, 2010). The government has been involved in redistribution of income for reducing the inequalities in the economy. In the growth review programme a set of policies are taken for driving a stronger growth rate of the GDP as there have been difficulties in terms of recovering from the recession. The incentive structure is changed in the labour market as the t ax rate is lowered for increasing the productivity of the labour (News.bbc.co.uk, 2015). The coalition government also implemented policies to reduce the budget deficit. Here a fiscal austerity policy is implemented which combines the tax rise and the spending cuts. A growth review programme is also conducted by the government. The expansionary fiscal policy can also lead to multiplier effects on the society. Here it can be said that an expansionary fiscal policy where the government expenditure may increase will increase the welfare and income of the economy (eHow UK, 2015). Here a positive multiplier effect will be evident if increased income will further increase the output by investing in the economy rather than saving. Similarly a contractionary fiscal policy led by a tax cut can lower the output by multiplier effect. The government has also implemented various monetary policies in order to control the business cycle in the industry. The monetary system basically includes the stability of price and how the government can restore stability in the money market. The coalition government of the UK has implemented policies in order maintain the price stability. The coalition government has maintained the rate of inflation at 2%. After the global recession of 2008, the government has taken measures to control negative impact in the economy. The interest rate rates were cut in the economy by implementing affective monetary policy (HM Government, 2010). So these are the main measures that are taken by the coalition government in order to smooth the business cycles in the economy especially after the global recession of 2008-09. References eHow UK, (2015).The uk's monetary policy | eHow UK. HM Government, (2010).The Coalition: our programme for government. 1st ed. Hoxley, M. (2010). UK coalition government.Structural Survey, 28(4). Hubbard, R. and O'Brien, A. (2013).Macroeconomics. Boston: Pearson. Krugman, P. and Wells, R. (2013).Macroeconomics. New York, NY: Worth Publishers. Mankiw, N. (2013).Macroeconomics. New York, NY: Worth. News.bbc.co.uk, (2015).BBC News - Policy-by-policy: The coalition government's plans. Painter, C. (2012). The UK Coalition government: Constructing public service reform narratives.Public Policy and Administration, 28(1), pp.3-20.