Demonstrate, using the 3-equation model, how these policies will impact (or have impacted) the UK economy? (Hint: policy makers assume a large negative demand shock)

These are the policies i have highlighted:

2. The living crisis/rising inflation was caused by many factors. Firstly, the war in Ukraine after Russia invaded has caused a rise in gas prices which is followed by a rise in electricity which links to gas prices and follows a similar trend. As well of this the bank of England states that the imports of gas have increased from about 10 billion per year before the pandemic to around 70 billion recently (Francis-Divine, 2022). The strong demand and increased costs for business, have caused a rise in the price of goods which were up 14.8% in October 2022 compared to the previous year. Finally, after the announcement of the mini budget the pound fell against other currencies, although after the reversal it recovered the decline, the pound was still 6% lower than it was in early 2022 (Francis-Divine, 2022). With a weaker pound it means that we must spend more to acquire the same amount of imported goods and services. To combat the living crisis/rising inflation the government have implemented an expansionary fiscal policy. This policy aims to increase government expenditure, this comes in the form of the announcement of the 'energy price guarantee', this would be introduced on October 1St and last two year and means that the government have capped the unit price of household energy and that the annual energy bill would be no more than 2500, which will be later increased to 3000 in April 2023, this means that the government will pay the difference to the energy provider. The energy price guarantee might cost around 25 billion and on top of this they are doing a similar scheme to non-domestic users such as businesses and charity's which might cost the government around a further 18 billion (Francis-Divine, 2022). The underlying motivation behind this policy is to use the tools of fiscal policy to help reduce the burden of rising inflation on households as well as boost consumer spending and increase aggregate demand. This policy has its limitations, as this policy favours the richer households and not the poorer households, although the Chancellor said that there will be direct cash to those on universal credit (Whyte, 2022), it does not tackle the core issue, as households on low income but not universal credit will see a rise in their energy prices. 0n the other hand with the government paying out money to households and the scheme cost, this will slightly further increase ination which would be adding to the problem. Another policy that the government have implemented is a contractionary monetary policy. This policy includes the raising of interest rates to 3% (Bank of England, 2022). The reason for this is that ination is too high and needs to come down, by raising interest rates the cost of borrowing increases and this means it is harder for households and businesses to access credit meaning people are less likely to borrow and spend money causing consumption to fall and a decrease in aggregate demand. The underlying motivation behind this policy is to use the tools of monetary policy to manage the demand of the economy and bring inflation back down to its target of 2%