As said in the post below, the world is falling in the deepest recession ever due to the banking crisis and the UK economy is not an exception. As seen in the diagram the economy will shrink by 4-5% in 2009 and there are hot discussions about the policies to deal with the negative growth.
At first let's deal with theory.(It's necessary to say that we assume that economy now is working far below full capacity and the recession is cause not by a shift of SRAS but by the shift of the AD.)
Monetary policy: Decrease Interest rates/Devaluation of the currency.
The first measure is likely to encourage people to borrow and discourage them to save therefore stimulate both consumption and investment. Second measure is likely to increase exports and therefore boost the Aggregate Demand.
Fiscal policy: Decrease taxes/Increase government spending.
First measure will increase people's disposable income and therefore is likely to increase spending. Second measure is a direct boost to the aggregate demand.
What is done by the UK government and central bank?
- Cut in the indirect taxes.
In addition to that government provides help for the small businesses.
Why these policies may not work?
- The devaluation may not work because exports are decreasing mainly because there is recession in other countries as well so the overall demand for exports is falling.
- Cut in the interest rates to 0.5% may damage confidence and the UK economy will end up as the Japanese during 1990s. Plus this doesn't affect confidence between banks and doesn't encourage banks to lend.
- Quantitative easing is too risky and may cause high inflation and fall in the purchasing power of money and that will only worsen the situation.
Cut in the indirect tax is likely to work when people HAVE money to spend.
Tough time for the chancellor,isn't it?:D.