Cuts In Public Expenditure Essay

Extract B (lines5-7) states: ‘this plan, laid out by the coalition government, implies the longest and deepest sustained periods of cuts to public spending since the Second World War’
Using the data and your economics knowledge, assess the likely impact of substantial cuts in public expenditure on the performance of the UK economy

The UK economy can be judged by a number of key indicators mainly sustainable economic growth, low inflation (target 2%), a surplus on the balance of payments and low unemployment. In this question I will explain the effect of cuts in public expenditure by the government on the performance of the UK economy.
Firstly if the government reduced its spending on public expenditure it will affect the economy in the short run as
government spending is a component of aggregate demand (AD) this is shown by the diagram below
[Diagram showing AD going down]
As you can see AD has reduced due to the lack of government spending
This could cause unemployment to increase as with lack of demand in the economy firms require fewer workers, this would be an increase in cyclical unemployment.
As unemployment has increased this mean consumers will have less disposable income and therefore will spend less on credit and save more thus causing AD to go down.
This situation could cause a downward multiplier effect which could have an even more negative effect on the economy as lack of demand could cause investment to go down in the future. This would have a very negative long term effect as lack of investment now could cause the productive capacity of the economy to decrease
[diagram showing AS going down]
As you can see from the above diagram lack of investment has caused AS to decrease in the long run
This could worsen the UK’s trade balance as goods become less price competitive as P1 goes to P2
Inflation has also increased in the long term as the economy can no longer produce enough to keep up with demand
However a reduction in government expenditure may not have such a catastrophic effect as government spending is not the only component of AD and ‘reductions in public spending could also create opportunities for the private
sector’
Also if the government cuts public expenditure it is likely to intervene using monetary policy (reducing interest rates) or fiscal policy (reducing income tax) to make sure demand is going
In conclusion it is important for government to cut its expenditure due to its growing budget deficit, but the short and long term are likely to be negative, however the size of the effect depends on the government reaction and the use of demand side and supply side policies to counteract the reduction in their spending