Joyeux Noel!

Bonjour buddies! Hola! The christmas days have come! How have you been doing?

Well... I am enjoying quite quiet times over Scotland. The region I am staying is pretty quiet and most of my university mates have gone back their home! Very very quiety and chilling out but very very very lonely christmas days! Today and tomorrow, I am gonna spend time at my good friend's flat to have christmas meals over 2 days.

The last semester has required me a load of works. The economic policy in Britain is a quite comprehensive course which enables me to analyse current econommic issues with using macroeconomic knowledges we have learned already. The economic policy in EU is a very interesting and beneficial subject as it indicates a lot of key issues involved in European Intergration in terms of both micro and macro economics point of view.


During the 4th year, I have to take 2 mathematics modules so I have attended so many lectures and seminars much more than not only majorities of the art-degree students but also other economics students taking economics as just a major or combining with accounting&finance or business management. I mean I have had a ton of works to do in my accademic life in this university, I wanted to say!

Any way, I hope all of you enjoy your rest of this year whatever you can deserve yourself! Cheerio!!

Economic Rationale --- Inflation rate should be refered/targeted?

The European Central Bank (ECB) is well known as a conservative central bank which adapts German model of monetary policy. The ECB is independent from government body and not allowed to have a contact with any community to determine their policy. Also the ECB has a little accountablity on economic situation as it is only interested in the inflation control. The ECN settle the reference inflation rate as 2%. This is different from the target inflation rate used by the Bank of England (BoE).


Focusing on the ECB monetary policy, it has been respected as the most stable inflation controlling one among all European Union (EU) members. According to the Barro-Gordom model, as the central bank with the lowest and stable inflation cotrol leads the monetary unions, all the member country of monetary union are benefited from the central bank. Barro-Gordom model indicates that the unemployment is structural and always the natural rate in the long-run so if the central bank sets the prefrence of the inflation rate lower, it enables the inflation rate stable over time. Also the country prefering higher inflation rate and lower unemployment does not success their policy to reduce the unemployment rate in the long run and the inflation rate eventually goes up in the long run. Therefure, Barro-Gordon model clarifies that countries would be better to follow the policy with lower inflation rate preference.

The ECB manages to control the inflaiton rate by means of the nominal interest rate. The ECB has a parliament constituted of representatives from all European Monetary Union (EMU) member nations. These representatives vote for the changing nominal interest rate. The decision is based on the majority voting system and all country have an equal power of vote.


On the other hand, there is a counter argument against determining the nominal interest rate by means of the inflation rate. Taylor argued that the output gap should be referred to settle the interest rate. Taylor indicated the importance of the output gap which is the gap between the potential economic activity level and the current economic acitivity level. This implies that the nominal interest should be changed not to target the inflation rate but to fill the output gap. In order to fill the output gap, if the real interest rate is lower the nominal interest rate should be increased and if the real interest rate is higher then the nominal interest rate should be declined regardless of the inflation rate.

Business-cycle and Ricardian-equivalence

The business cycle is an important objective to refer in order to operate an economic policy. Controlling business cycle is a significant policy for government because during the recession, government inevitably have to spend for the social security due to rise in both unemployment rate and the absolute poverty rate i.e. fall in the average income level. These factors are very crucial elements in economy because these factors are (In particular, unemployment is) a lugging indicator in economy. There are two main government demand management policies intervening into the business cycle; the monetary policy and the fiscal policy.

Some economists put priority on the counter-cyclical government expenditure plan. This policy connotes the fiscal policy is effective to control the business cycle. This reason is based on Keynesian theory denoting that the liquidity of money supply by the monetary policy is ineffective. These economists believe that the increase in government expenditure helps to overwhelm economic recession rather than the extra cash flow. Furthermore, the tax cannot be increased during the recession time as tax rise may perpetuate the recession. Therefore, they support to reduce the tax in order to stimulate the economic activity and incur national debt in order to cover the cost for the government expenditure.

By contrast, this point of view has been contradicted by Neoclassical economists. According to the Neoclassical point of view, the tax deduction does not have much impact on economy. The reason is that individuals may prefer save the amount of extra income from tax deduction to predict their extra expenditure for the interest payment for the government debt. This theory is called "Ricardian Equivalence".



Focusing on the graph, individuals prefer spending for consumption at both current and future time at the level of their utility curve. Therefore, although there is an tax deduction it does not have any effect on the current consumption level and eventually they still have to pay the interest payment through taxation in order to pay back for the debt incurred in the past. Thus, Ricardian equivalence states that the fiscal plan should be fixed over time.

Neoclassical theorists put emphasis on the monetary policy and the supply-side reforms in order to tackle with the recession.


Nevertheless, there has been a counter argument against Ricardian equivalence. Some economists argued that Ricardian equivalence might be true if the recession is not serious and the absolute poverty level is lower. Otherwise, tax deduction and
debt incuring are required.



Focusing on the graph above, if individuals have not gained enough income to consume, the extra tax deduction can increase the current consumption level because it expands the borrowing constraint. During the recession, some individuals may face this borrowing constraint which denotes the incapability of their income to both spend and save. Therefore, the Recardian equivalence might be contradicted in terms of the aspect that unless tax deduction and debt incurring take place, it may induce the recession lugging.