Macroeconomics

Posted: October 17th, 2013

Macroeconomics

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Macroeconomics

The United States federal government strives to improvise and provide economic policies that are beneficial for the growth of a healthy American economy. An economic policy that proves to be advantageous to one segment in the society can prove to be injurious on another segment. This can be illustrated by the relationship encompassing policies for unemployment and inflation. For instance, increasing interest rates in order to decrease inflation in an economy augments difficulty for businesses to obtain capital for expansion purposes. Such purposes enable the business to employ more workers. Thus by increasing the interest rates, unemployment will increase. Lowering the interest rates creates inflation due to increased spending. This, in turn, devalues employees’ salaries because of the rise in prices. In order to affect the economy positively, it is valid to create efficient economic policies.

Part 1

To preserve a sturdy economy, there are policy goals that require to be adhered. These policy goals include stable prices, economic growth and full employment. Regarding stable prices, the economy should be characterized by an optimal level of prices for goods and services. However, most economies have experienced a shift in the stability of prices. The most common shift of prices is inflation. This is when the prices for products and services rise sharply further reducing the value for money. This causes an increase in costs of goods. Economic growth is indicated by the Gross Domestic Product (GDP). The GDP is the value of the total output of products and services in the country in dollars. A flourishing economy can possess a GDP growth rate of 4 percent. Full employment cannot be achieved since there are various reasons that arise to unemployment that cannot be controlled. However, an unemployment rate of 4 percent is less is denoted as full employment (Carlberg, 2008).

Hence, it is understandable why the federal government maintains its GDP at 3 percent. In the case involving the country being in a stage of high unemployment, zero interest rates, inflation at 2 percent per annum and a GDP of less than 2 percent, it is necessary to incorporate economic policies that will maintain the country in a thriving state. These policies involve the fiscal policy and the monetary policy. Fiscal policy involves the utilization of taxation and government expenditure to change the economy. Hence, the main tools used in invoking fiscal policies in the economy are expenditure and taxation (Kopcke, Tootell & Triest, 2006). Monetary policy involves the control of money supply in the economy. This duty is usually performed by monetary authorities such as the Federal Reserve. This policy usually involves promotion of escalation and stability of an economy by targeting interest rates (Fender, 2012).

In such an illustrated economic environment characterized by zero interest rates and a marginal of less than 2 percent GDP growth, it is a requirement to implement fiscal and monetary policies that will stimulate economic growth. Therefore, as president, I would recommend the use of fiscal policies. In this case, the fiscal policies will be used to reduce taxes imposed on small and medium enterprises, as well as households. This is because they are the main drive for the economy. This can be further indicated by the fact that the small and medium enterprises avail more employment than large and multinational companies. Hence, there will be an increase in employment, which will lead to a reduced multiplier effect due to increased income circulation among employees (Kopcke, Tootell & Triest, 2006). Moreover, I will introduce tax rebates and inducements to the large corporations that are in partnership with the businesses. This move will increase confidence among consumers and amplify aggregate expenditures within the private sector.

As the Chairman of the Federal Reserve, I would employ efficient monetary policies specifically targeting the interest rates. This is because interest rates affect the productivity of the economy since they define unemployment. Additionally, an expansionary monetary policy can be used to lower interest rates in order to avail credit to businesses hence increase employment. Thus by maintaining a zero percent interest rate, people would be able to obtain credit for growth of businesses. The increased employment in turn increases the GDP rate because Okun’s Law states that, for every decrease in unemployment, the GDP increases thrice. Moreover, I would lower rates for the acquisition of funds from the Federal Reserve (Sexton, 2002). This strategy will encourage the banks to borrow finances from the federal banks. Moreover, the action will enable the banks to possess and avail more liquid cash for enterprises and private loans for the unemployed and underemployed.

The positive effects of these actions revolve around the effects of the policies on consumption. This is because by using the fiscal policies to reduce tax rates; there will be an increase in the purchasing power since there will be an increase in small and medium enterprises, which will have an increased demand for money. This, in turn, will increase consumption. Moreover, the increased consumption of goods and services will increase the supply of money in the economy. Additionally, an increase in businesses avails more employment thus lowering the unemployment rate in the economy in the short run (Carlberg, 2008). Moreover, the positive effects of such policies will lead to the relocation of revenues to the private sector from the government. This is attributed to the low rates of income taxes. This is because of the reduction of taxes on households and small businesses. Hence, the fiscal policy adapted will establish control of revenues by the private sector, which have better management of funds, and revenues when compared to the private sector.

The negative effects of the policies are based on the effect of the actions on the amount of revenue the government will receive. Indeed, there will be reduced revenue for the government. This is attributed by revenue transfer from the public to the private sector. Moreover, the government is heavily dependent on the revenue received from taxation. Therefore, the reduction in taxes accorded to small enterprises will decrease the revenue the government receives from taxation of the businesses. Furthermore, the decrease in income taxes also lowers revenue taxed on employees. The increase in unemployment in the end will be a negative effect on the government. This is because the decrease in the rate of employment will lead to increased money circulation, which will eventually lead to an increase in spending. The increase in spending will lead to inflation. According to the Philips Curve, the lower the unemployment rate of an economy, the faster the payment of labor wages in the economy (Carlberg, 2008). This eventually leads to inflation since demand for products and services overlaps the supply causing producers to increase the prices to restrict the purchase which increase the costs of production.

The trade off resulting from the employment of the specific policies in contrast with other monetary and fiscal policies is the amount of time taken for implementation. This is because such policies will take longer time to implement. The reason for this is attributed to the novelty of such measures as compared to the commonly used policies the federal government implements. Despite the delay in the implementation of such measures, in the economy, it is important to recognize the positive effect of the measures since they will lead to the lowering of the unemployment rate, the increase in the rate of GDP, the increase in income circulation in the economy attributed to increased businesses and purchasing power and ease of credit access for potential borrowers. Moreover, since inflation is low, households will experience minimal difficulty utilizing their wealth to purchase products and services. It will probably take a considerable amount of time to gain an increase in spending and a decrease in unemployment.

Part 2

The debt to GDP ratio indicates an economy’s health. It refers to the measure of the federal debt of the country in relation with the gross domestic product of the country. The comparison between the country’s debts to what the country produces reveals the country’s ability to repay the debt. The economic indicator gives a notion of the country’s ability to create future payments on what it owes. If the country were not able to repay the debt, then it would default leading to pandemonium in the household and international markets. A low debt to GDP ratio portrays large production of products and services as well as significant profits by an economy. This indicates that such an economy is able enough to repay its debts. Governments particularly aim for low debt to GDP ratios and have the ability to support themselves against risks involved by increasing debt since their economies possess a high GDP and profit margin. The inverse, a high debt to GDP ratio indicates portrays low production and a low profit margin, which indicates the inability of the economy to repay debt and default (Frumkin, 2006).

If the country has a budget deficit and carries a large debt, then it signifies that the country possesses a high debt to GDP ratio. The negative effect of a high debt to GDP ratio relies on the impact of fiscal policies in the economy. This is because an increase in the ratio is determined by government spending. The impact associated with a higher debt to GDP ratio can also be related to the impact of monetary policies in the economy. This is mainly because a high debt to GDCP ratio has a considerable impact on the interest rates. Therefore, the implications of a high debt to GDP ratio involve interest rate repercussions, increases in tax and enhanced cuts on spending (Frumkin, 2006). Regarding interest rates, the ratio will increase the interest rates of treasury bonds and indicate a higher risk. Regarding tax increases, the government will be required to increase taxes and reduce spending in order to gather finances to repay the debts.

To expound further on the ratio’s impact on the interest rates, the rates replicate risk in the treasury bonds. Therefore, the higher the debt to GDP ratio, the higher the risk rate of the bonds (Frumkin, 2006). Consequently, if the Treasury bond possesses a risk rate that is high, then the government has the mandate to offer bondholders additional interest in order to receive more finances. Hence, countries with a high debt to GDP ratio are considered to possess default risk. Therefore, such countries cannot borrow cheap finances from bondholders. A high debt to GDP ratio will also increase the susceptibility of increase in taxes and cuts on spending. This is because the country with a high debt to GDP ratio bears high debt and thus will be obligated to reduce the deficit at a point. A national default can prove disastrous for the economy hence raising taxes and lowering expenditure are the common methods used to lower the ratio and fill up the budget deficit.

Another impact that a high debt to GDP ratio will have on the economy is the disequilibrium of the macro economy. The equilibrium of the economy is usually attributed to the balance between aggregate demand and aggregate supply. Aggregate demand refers to the total demand for products and services at a given period and price. Aggregate supply refers to the total supply of products and services that companies plan to sell in a given period. Disequilibrium arises whereby a higher debt to GDP ratio leads to the decrease in the rate of production caused by the increase in interest rates and reduced purchasing. Additionally, low production will cause a subsequent decrease in products and services in the economy and thus lead to decreased demand. This causes macroeconomic disequilibrium in the short run (Wickens, 2008). However, in the long run aggregate demand and aggregate supply will intersect because of the decrease in production leading to low supply that will eventually lead to an increase in prices and a decrease in demand.

A high debt to GDP ratio will also lead to the redundancy of government employees and workers. This is because the government seeking to close up its budget deficit will require lowering the amount of wages it avails to its employees by laying them off. This shall lead to an increase in the unemployment rate in the economy. This can affect the business cycles of the economy and increase the fluctuations because an economy operating at high unemployment will reduce the economy from reaching short run equilibrium. In most cases, a cycle such as the debt cycle shifts credit expansion to credit contraction hence lowering the economic growth of the country resulting from decrease in private credit and an increase in recession. Therefore, by laying off workers, the government will decrease the multiplier effect on the economy since there will be no injection of new demand in the economy (Knoop, 2004).

The effect of the ratio on the proposals will have an effect on the fiscal polices proposed. This is because there will be an increase in the rates of tax on income. By increasing the tax rates as a method of fiscal policy, the small enterprises and households will not be able to acquire funding from banks since the tax rates will also affect the banks, which will in turn increase their lending rates resulting from the federal banks’ directive. This will lead to unemployment because the enterprises will either lay off their workers or retain the ones they have without considering employment of other workers. The monetary policies employed will also be affected because of the high risk of interest rates on the treasury bonds. Since the government will seek to raise extensive finance to allow for the purchase of bonds, it will have to lower its expenditure in order to cater for the financing of high interest rates for the bondholders. This leads to underdevelopment of the economy resulting from the under financing of public amenities such as infrastructure that are important for the development of the economy in terms of increase in GDP.

It is important for an economy to analyze its policies efficiently and adequately to determine if they are probable enough for the development of the country. Such policies if reviewed clearly can guide a country to economic prosperity since they will be created based on achieving increased value in economic indicators such as the GDP. Moreover, the policies can aid the country in focusing on financial forecasting, which can enable it determine inflation and deflation rates and how to mitigate such unsystematic risks.

References

Carlberg, M. (2008). Inflation and unemployment in a monetary union. Berlin, Germany: Springer.

Fender, J. (2012). Monetary policy. Hoboken, New Jersey: Wiley.

Frumkin, N. (2006). Guide to economic indicators. Armonk, New York: M.E. Sharpe.

Knoop, T. A. (2004). Recessions and depressions: Understanding business cycles. Westport, Connecticut: Praeger.

Kopcke, R. W., Tootell, G. M. B., & Triest, R. K. (2006). The macroeconomics of fiscal policy. Cambridge, Massachusetts: MIT Press.

Sexton, R. L. (2002). Exploring economics. Mason, Ohio: South-Western/Thomson Learning.

Wickens, M. (2008). Macroeconomic theory: A dynamic general equilibrium approach. Princeton: Princeton University Press.