UAE Economic Recovery and Fiscal Policy

Summary of the article

The International Monetary Fund estimates that the United Arab Emirates’ economic growth will slow down from 3.9 to 2.3 percent in 2012 due to the consolidation policy by the Gulf States. The economy of the United Arab Emirates is likely to continue with the same trend due to the low oil prices in the market. Moreover, the country does not intend to increase oil production in the near further which has caused the economy to stagnate at 2.3 percent. Analysts estimate that the economic growth rate will decline from 3.9 percent in 2011 to 2.3 percent in 2012.

The high oil prices and strong trading relationship with other Asian countries have helped the country to recover from the financial crisis in 2009, which led to a $25 billion debt restructuring in the iconic Dubai World. However, the IMF warns that a worsening global economic environment might limit the ability of the country to overcome its current maturing debt obligations. Although the country has made progress in debt restructuring, the economic situation might pose a threat to the success of debt restructuring.

Stage in the business cycle of the economy

The economy is moving from recession to recovery or revival phase. The United Arab Emirates’ economy is recovering from the 2009 financial crisis. Although the GDP growth in 2012 is expected to decline, there is a rise in economic activities such as an expansion of business trade with Asian countries. The economic growth declined in 2012 because the country was undergoing a $25 billion debt restructuring. During the recovery phase, the level of demand starts to rise, and production increases which cause a rise in the level of investment. During the recovery phase, there is a steady growth in employment, prices, and profits.

Two reasons why the economy is on recovery

The reason why the economy is in its recovery phase is due to the steady increase in profit and income. In 2012, the total amount of imports was $273.5 billion, which was higher than that of Saudi Arabia, which is the largest consumer in the region (Wam para. 4). Moreover, export increased to $314 billion in 2012, which was also the highest in the region. The United Arab Emirates’ growth is attributed to the increase in trade with other Asian countries and especially with India. The trade between India and the United Arab Emirates totaled over $75 billion.

China and India play a critical role in the recovery of the economy, which was in a deep recession after the global financial crisis. The debt restructuring has delayed the country from moving to the next business cycle because it has to meet its obligations instead of economic growth. Asia has enabled the economy to recover because of increased trading which has improved economic activities. Dubai’s economy is dependent on oil, tourism, and real estate. After the financial crisis, a country’s economic growth has been growing at a steady pace as it recovers from the crisis.

Secondly, Kawach noted that although the economy is growing at a high pace Dubai is still recovering from the oversupply of residential houses and commercial properties (para. 3). For instance, during the global financial crisis, a standard house was costing $400,000 per 1,100sq. ft., which is now available at less than $110,000. This is a clear indication that the economy is still recovering. During the recovery phase, economic growth increases and decreases due to debt restructuring.

However, improved consumer sentiment has helped the retail sector to recover from the global financial crisis. The retail industry spending increased in the first quarter of 2011. For instance, Chinese tourists have increased retail spending which helped the economy to recuperate. For instance, some retail giants were allowing Chinese businesses to take credit, which was more than 30 percent of sales.

The right fiscal policy that should be followed

In 2012, Dubai was pursuing an expansionary monetary policy by keeping interest rates low in order to encourage investments in the economy. When the central bank lowers interest rates, banks can be able to lend money at low-interest rates, which bolster economic growth (Kaya 72). Although there was a sharp decline in domestic credit, the UAE central bank believed that banks were not too risk-averse which allowed them to lend money at low-interest rates. Dubai’s central bank decided to settle on an expansionary policy because the global economic environment continued to pressure the economy. To overcome this pressure, the government decided to pursue an expansionary policy to stimulate economic growth.

Explain why this fiscal policy should be used

An expansionary policy was a prerequisite to encourage the economy to recover and grow. The central bank kept interest rates low, which have supported an expansionary policy by depleting the bank’s reserves that enabled the central bank to take care of the multiplier effect in the economy. The most critical pillar of Dubai’s expansionary policy was the banks, which we’re encouraged to be less risk-averse to allow customers to borrow and invest in the economy. According to Dubai’s central banks, the credit growth increased by 2.4 percent in 2012 compared to 2011 which is an indication of the economy to pursue an expansionary policy.

The policy encourages economic growth. The United Arab Emirate government pursued it in 2012 to stimulate economic growth and create job opportunities in the economy. The budget was expected to focus on prudent fiscal policies that will boost economic growth. These goals were achieved through the application of an expansionary policy by the central bank, which kept interest rates low to encourage lending. Expansionary policy is achieved when the central bank lowers interest rates in order to increase employment. Moreover, the expansionary policy is intended to entice businesses to acquire finances in order to expand. This policy is achieved by increasing the amount of money in the economy, which encourages aggregate demand to grow.

Monetary policies target consumption and investment. When the central bank reduces interest rates, it encourages private consumption and investment. Aggregate demand increases due to raised private consumption and investments. This policy is clearly indicated in the 2012 budget, which was expected to create more than 1600 jobs. The expansionary budget raised public spending to $9.28 billion which was a-6-percent-increase compared to the previous year. However, the government ensured that the level of inflation and employment remained controlled to prevent them from affecting the long-term economic growth prospects. Due to the amount of money injected by the central government in the economy, it was able to encourage private consumption, which pushed the interest rates down leading to higher aggregate demand.

Dubai was pursuing an expansionary policy to increase public spending that creates job opportunities and increase inflation. When the economy is experiencing an expansionary policy, there is a lot of money in the economy, which pushes the prices of commodities high causing inflation. The 2012 budget increased public spending to $9.28 billion, which implies there was a lot of money in the economy. Consequently, the level of inflation had to grow. The existence of an expansionary policy is supported by Arnold, who noted that Dubai’s inflation index grew by 4.3 percent compared to that of 2011 (762). Dubai’s central bank enacted an expansionary policy through open market operations.

In 2012, the government redeemed most of its bonds in the market which increased money supply in the economy. The action of the government increased the money supply in the economy, which also promoted investment. Since the banks that possess government bonds had more money to inject into the economy, it made easy for the banks to lend money, which increases the money supply in the economy.

The United Arab Emirates government expected that borrowed money would be used to expand operations in the economy, which would lead to increased job opportunities. This argument is consistent with the state budget, which estimated that by injecting $9.28 billion in the economy, it would create 1600 jobs. Therefore, the government was pursuing an expansion policy, which aimed at increasing job opportunities and public spending.

Impact of an expansionary policy on the economy

An expansion policy increases the level of inflation and lowers interest rates in the short run. When the federal fund rate is reduced, it causes a high demand for goods and services, which ‘pushes up’ the wages and other costs. It reflects the high demand for workers and materials used during production. Consequently, there will be a lot of money circulating in the economy, which will drive the cost of goods and services high thus, causing inflation.

When the central bank injects additional money into the economy, there is an immediate impact on the short-term interest rates, which is reflected in the bank’s willingness to increase loans. Coutino argues that when a country pursues an expansionary policy, inflation will rise because there is a lot of money in the economy, which will cause the price of commodities to increase drastically (58).

Therefore, in most cases, an expansion policy is not sustainable indefinitely. This is because an expansionary policy requires a lot of money to be injected into the economy. In most cases, these funds come from borrowed funds. Thus, if the government fails to control the duration of an expansionary policy, the budget deficit will rise driving up its debts to levels that are unmanageable in the long run. Therefore, expansionary policy is perceived to be a short-term policy and not a constant one. Expansionary policy is applied by governments during recessions and economic slowdown to stimulate economic growth.

An expansionary policy will cause an increase in gross domestic product. As the GDP rises, it stimulates the demand for imported goods, which has a negative effect on the current account. Consequently, there will be a need to convert the domestic currency to a foreign one that will cause the exchange rate to decrease. Usually, the expansionary policy is used to stoke economic growth and to create a job, which is based on the Keynesian Theory of Economics.

An expansionary policy increases both output and productivity in the economy. When the United Arab Emirates government pursues an expansionary policy, it will cause an increased output in the economy due to aggregate demand. Since reduced taxes characterize an expansionary policy, the Keynesian theory assumes that people will use the saving from taxes to buy goods and services in the economy (Gwartney 309). The increasing consumer demand for output will encourage producers in the economy to increase the production of output in order to meet the current demand in the market.

Thus, high demand will raise the level of production and productivity within the economy (Lutz 93). If the Dubai government decides not to lower taxes but to increase government spending, it will prompt producers to raise production to meet the level of demand. According to Keynesian theory, it is irrelevant where the demand comes from as long as it stimulates production in the economy. In other terms, expansionary policy can be viewed from the perspective of the field of dream where an increase in aggregate demand will stimulate productivity in the economy.

An expansionary policy increases the level of employment in the economy. This notion is supported by Keynesian theory, which argues that an increase in aggregate demand will drive up the level of production thus creating more job opportunities. Due to the increasing demand in the market, companies will tend to hire new workers in order to increase production. However, economists have criticized this theory. They argue that technology has shifted productivity and efficiency in the workplace. Most companies are using modern technology to increase production without necessarily hiring new workers. In the long run, an expansionary fiscal policy will have a negative impact on the gross domestic product due to long-range aggregate supplies (LRAS).

According to Keynesian theory, during an expansionary policy, the supply curve does not change because the fiscal policy causes a rise in the price of goods and services, which causes the aggregate supply curve to shift left (SRAS). Therefore, the aggregate demand curve of the gross domestic product intersects with the LRAS curve at a point where there are a high price level and a low gross domestic product (Baumol and Blinder 73). Therefore, the Keynesian theory argues that the economy will be unstable. However, the fiscal policy will be more effective because it can be structured to prevent crowding out of investment expenditures.

Keynesian theory has been criticized by monetarists who argue that the economy will be stable and that the monetary policy will cause a high crowding-out of investments in the economy. However, the disagreement revolves around what constitutes too much crowding out of expenditures in terms of external investments. In fact, Keynesian perceives the issue of crowding out as undesirable and justifiable as it stimulates aggregate demand quickly. However, monetarists hold the view that crowding out is undesirable since a stable economy has its mechanism of correcting itself. Nonetheless, many economists have rejected the monetarist’s view because it cannot be proven in the real world.

Impact of an expansionary policy on output and employment

An expansionary policy has a direct impact on the money supply in the economy, which causes an increase in nominal output in the economy. When the central bank injects money in the economy, it increases supply which has the multiplier effect because consumers will tend to spend more on goods and services. Consequently, producers will raise the level of output in order to meet the demand in the market.

Thus, the expansionary policy will cause the aggregate demand curve to shift right (Auerbach and Kotlikoff 216). When there is a lot of money circulating in the economy, the supply curve will move up along the aggregate supply, which will lead to high prices and more output. Producers hire new employees in order to meet the current demand in the market. Consequently, an expansionary policy will cause more job opportunities within the economy. This notion is supported by the United Arab Emirates’ budget when an injection of $9.28 billion is expected to create 1600 jobs.

An expansionary policy creates employment in the economy. An increase in aggregate demand in the economy will stimulate production, which will create new job opportunities. The Keynesian theory argues that an increase in aggregate demand will cause companies to hire new employees to meet the high demand for consumer goods. Therefore, there is a direct connection between the level of output and job creation. However, what is clear is that an expansionary policy stimulates production output, which has a direct impact on job creation.

When the central bank lowers the interest rates, it becomes cheaper to borrow which allows households to buy goods and services (Ricci 249). On the other hand, firms are more willing to purchase items (raw material) to acquire high demand in the market. Businesses will respond to an increase in aggregate demand by hiring new workers. However, the relationship between expansionary policy and employment does not show up quickly because it is influenced by various factors, which cannot be gauged precisely.

Conclusion

The United Arab Emirates government had pursued an expansionary policy in 2011-2012 fiscal years. The economy was still recovering from the 2009 financial crisis. However, China and India play a critical role in the recovery of the economy, which was in a deep recession after the global financial crisis. The debt restructuring has delayed the country from moving to the next business cycle because it has to meet its obligations instead of economic growth. The expansionary policy enabled the country to repay its debts. The government pursues an expansionary policy in order to stimulate economic growth and job opportunities.

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