11 Pages, Grade: 1
Firstly it is important to define what the economic challenges are to understand and explain how the policies are used to achieve these. Economic challenges are usually associated with a countries economic objectives which generally include sustainable economic growth, low targeted inflation and also the more argued topic of full employment. According to Vickery (1993) full employment is: “a situation where there are at least as many job openings as there are persons seeking employment, probably calling for a rate of unemployment, as currently measured, of between 1 and 2 percent”. This partially agrees but argues with Beveridge’s well known definition argued that there will always be unemployment due to frictional unemployment so argued that ‘full employment’ exists when there is around 3% unemployment. There are other objectives such as public finances, inequality and environmental issues, although the three main objectives tend to take priority and precedence to other objectives especially when evaluating the role of central banks and the economy. In terms of central banks for these nations, they are all in control of monetary policy, so it needs to be analysed how effective monetary policy is to respond to economic challenges. Before analysing the role of the central banks, Europe, is a Union of countries and thereby needs to be quantifiably subjected compared to the individual nations of Japan, the U.S. and the U.K. The European Central Bank will represent Europe and its 19 EU member states that use the Euro currency, this will help put into perspective the policy of the European Central Bank (ECB).
The European Central Bank has control over monetary policy of its 19 EU member states that use the Euro currency and are thereby required to manage the stability of the Euro and inflation and also to assist in controlling the European Economy. In order to achieve their economic objectives, the ECB has only a ‘one size fits all’ scenario in that they have to adapt monetary policy over all these countries. Issing (2014) argues that “The ECB therefore focuses on its own mandate, with the primary objective to maintain price stability, leaving others to meet their own responsibilities.” He goes on to say that: “One size must fit all”. This approach of the ECB allows independence of monetary policy from political involvement while governments in the Eurozone can take care of their own fiscal policy and not influence the short-term of an economy for political gains .In the case of the ECB, fiscal policy is down to its member states to manage themselves as the ECB has no involvement in taxation and government spending. This is arguably not the best for certain countries, Nedvěd states that: “…Ireland, Greece and Spain experienced relatively high inflation rates and highly positive output gaps…they needed to raise the interest rates. Nevertheless, they were not able to do that since the monetary policy had been in hands of the ECB and the interest rates had been tailored to the whole Eurozone.” This argument emphasises the difficulties in managing multiple economies through monetary policy as it can’t be used to control the economies of certain countries whose economies aren’t in line with other members of the Euro.
The global financial crisis that hit in 2007 led to high unemployment in many of the countries in the Eurozone. Eurostat states that in August 2014 Greece had an unemployment level of 25.9% while Spain had 24.2% unemployed. This unemployment level is very large and has not only damaged economic growth and political parties but also caused poverty and other issues such as stagflation. To counter this, the ECB has decided to buy bundles of asset-backed securities (ABS) and covered bonds, in mind to increase the price level closer to its target of 2% and hopefully increase confidence within the EU in terms of banks lending more to businesses and consumers. Jones (2014) states that “By signaling the ECB’s intent to rid the currency area of the very real threat of economic stagnation, a sizeable, broad programme of private-sector asset purchases could damp pessimism. As the same time, it is likely to weaken the euro, aiding the region’s exporters…” This benefits the EU as exports brings cash flows into the EU and increases economic growth potentially while also leading to investment from businesses in expanding and trading abroad. Jens Weidmann, President of the Deutsche Bundesbank (2014), however, disagrees with the ECB and what Jones has to say, stating in a speech that: “The biggest bottleneck for growth in the euro area is not monetary policy, nor is it the lack of fiscal stimulus: it is the structural barriers that impede competition, innovation and productivity.” This might signal that more cohesion between the ECB and policy makers in that there may be too much ‘bureaucracy’ and ‘red tap’ and not enough of a ‘free market’ system within Europe for businesses to grow and compete allowing for more employment, economic growth and an increase in the price level. In the case of the ECB, they are trying to do all they can to spark the EU Economy with what they have and have made some progress through setting measures on financial institutions to try and prevent another banking crisis, however, it might be up to policy makers in the EU to allow for less of a bureaucratic system and to not ‘crowd out’ businesses.
The Bank of Japan has similar functions which the Bank’s charter states that the three functions of the BOJ is to be: “Issuer of banknotes”, “Bank of banks” and the “Bank of the government”, while also being in charge of monetary policy, independent of the government’s political agenda. Japan has struggled with periods of stagnation pushed by the lowering of average wages. Etsuro Honda, an advisor to Prime Minister Shinzō Abe and key to Abe’s reflationary policies states in an interview with Reuters that: “In order for income effects to work, wages must increase”. One of the methods of re-inflating the economy is through quantitative easing. An article by the Economist (31/10/2014) states that the new expansion on quantitative easing will “swell Japan’s monetary base at an even faster pace, by around ¥80 trillion ($712 billion) each year”. The result of this is not only does it increase inflation due to more currency being injected into the economy but investor’s may expect further inflation so in the case of Japan which required inflation will raise confidence and expectations for growth. On top of this it may also lead to more bonds being sold while lower interest rates will encourage businesses to grow through investing by borrowing at low rates. Consumers may also get cheap credit for purchases, this should theoretically allow Japan to grow. According to the theory on aggregate demand, an increase in consumption (C) and investment (I) in the formula of AD = C+I+G+(X-M). Figure 1.1 (RevisionGuru 2015) indicates the impact on aggregate demand of an increase in consumption and investment if everything else is equal will cause the aggregate demand to shift to the right from (AD) to (AD1). The impact of this is the price level increases from (P) to (P1) and the national income/output to increase from (Y) to (Y1), while the equilibrium rises from (P) (Y) to (P1) (Y1) upwards along the aggregate supply curve. This method appeals to Japan as it should help to try and push up wages, employment and the price level in the economy benefiting growth in the short-run aggregate supply. Keynes argued that: “Long run is a misleading guide to current affairs. In the long run we are all dead.” As mentioned, this may seem all fine in theory, however, aggregate demand theory is considered highly short term and may not be beneficial in the long-term as confidence of say quantitative easing may disappear if the scheme isn’t that successful. McLannahan (2014) states at the end of the year that: “a variety of indicators suggest that broad inflation expectations are flat, if not falling. The BoJ’s own quarterly survey showed that companies’ forecasts of rises in output prices were weaker in December than in October, almost across the board.” McLannahan goes on to state that “A preliminary CPI reading for December in the Tokyo area – considered a leading indicator for the rest of the country – showed core inflation at just 0.3 per cent, excluding tax effect.” This result is extremely damaging for Abe and his “Abenomics” reflationary plans whose inflationary target of 2 per cent is not being met. This is only made worse with the chief strategist at SMBC Friend Securities in Tokyo, Toshihiko Matsuno (2014) stating that: “Many investors do not believe that Japan can get pulled out of deflation.” This notions that the Bank of Japan is struggling to inflate the economy, however, there are other methods that could help them to do this. Pesek states that “liquidity isn’t enough; banks and corporations need incentive to tap that money.” This is one of the main issues of quantitative easing in that, if the money isn’t being spread and injected into the economy to businesses and consumers, inflation may not be as strong. One of the major recent issues that is also not helping the Japanese economy in inflating is the drop in the price of oil. According to the CNBC oilprice (2014), crude oil on the 6th January oil prices closed on $48.46 a huge drop from 6th October to $87.67 on close. Japan imports a majority of its oil which in terms could be considered good as there would be lower fuel prices for consumers and lower the current account deficit, however, this may not necessarily inflate prices as energy prices would also decrease for energy providers in Japan meaning it would impact the effort to raise inflation.
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