The Effect Of Changes in Government Expenditure and Exchange Rate on The Income Of The United Kingdom

This paper examines the effect of changes in policies relating to fiscal policy, monetary policy and international competitiveness and trade flows within a Mundell- Fleming type open economy model by using time series data of the UK economy. Policy scenarios was analysed using ex-post forecasts from 1990 to 2001 and ex-ante forecasts for 2001-2020. The results indicate that the expansionary policy, with growth of government expenditure, by various percentages, will raise income and as a consequence, the predicted values of tax, consumption, and imports will increase. However, when using a contractory policy, cutting government expenditure, by different percentages we find that the most notable outcome is the decrease in predicted tax. This decrease for income, consumption and import is shown in the early years of the forecasting period. However, in the long run, these variables will increase. Concerning the monetary policy represented in change in the exchange rate, we have two cases. When the pound appreciates against the dollar, it was found that exports fall and imports rose causing net exports to decline. Import will increase in the first three years. The predicted values of income, consumption and tax will increase. The opposite happens in the second case which is the depreciation in the pound. Finally, impulse response analysis is used to determine the response of income, consumption, and investment over time to a shock.