Fiscal and Monetary Policies

Fiscal and Monetary Policies
Fiscal and monetary policies focus on quickly returning the economy to sustainable, healthy growth. Any type of fiscal relief package will boost consumer and business spending and can augment the nation’s long-term growth

potential. Expansionary monetary policy can stimulate growth and provide insurance against the possibility of deflation.

Both fiscal and monetary policies affect aggregate demand. But because discretionary fiscal policy changes in the U.S. are often difficult to enact in a timely fashion, automatic fiscal stabilizers and discretionary
monetary policies are commonly viewed as the primary policy tools for macroeconomic stabilization. However, there are situations in which monetary policy might be unable to stimulate the economy, and discretionary fiscal policy would be needed to combat a recession. In the face of a recession, central banks reduce interest rates, but no central bank can lower interest rates below zero.

Fiscal policy, the taxing and spending policies of the federal government, also has the potential to influence economic conditions. Throughout 2002-2004, I remember all the debates made in Congress about what to do with spending and taxes in order to stimulate spending. Taxes were lowered and spending increased. This debate is one of the key differences between fiscal and monetary policy. Fiscal policy is much more difficult to implement. However, fiscal policy, once adopted, is likely to have a faster effect on spending. Monetary policy decisions are much easier to institute and more responsive to economic conditions, but take longer to actually have an effect.

1. GDP growth is approximately 1.5%, and has been at approximately that level for two years.
The Gross Domestic Product (GDP) is the sum of good and services produced in the United States for a given period. It is an indicator of general business activity, economic growth and a good index for the economy. The most widely followed measure of economic growth is Real GDP, which adjusts GDP to remove the effects of inflation.

The anemic annual GDP rate of growth of 1.5% above over the past two years is well below market expectations. This lack of growth may be attributed to effects from job growth; tax cuts and lower interest rates. The rate of economic growth means the percent change in Real Gross Domestic Product (RGDP). The low GDP can also be attributed to consumption, investment and government expenditures and net exports.

2. Inflation as measured by CPI&GDP deflator has been approximately 1-2% for the last 2 years.
Inflation has been defined as a process of continuously rising prices or equivalently, of a continuously falling value of money. Various indexes have been devised to measure different aspects of inflation. The purpose of the Consumer Price Index (CPI) is to measure the purchasing power of wages paid to an average urban worker. The weights used for the CPI are the quantities of goods and services purchased by the average urban wage earner.

The CPI measures inflation as experienced by consumers in their day-to-day living expenses and the Gross Domestic Product Deflator (GDP Deflator) measures combine the experience with inflation of federal, state and local governments. There are specialized measures, such as measures of interest rates and measures of consumers’ and business executives’ expectations of inflation.

While the low inflation of 1%-2% above is desirable, too low inflation or outright deflation may be harmful. I think a pickup in economic activity in this example would be expected to help minimize the risks of deflation. It seems there is a relationship between the growth of production and inflation, so that lower production growth leads to lower inflation, or higher production growth leads to higher inflation. The inflation described above also means there is more demand or money than there are goods and this causes an increase in prices and drives down the worth of the dollar.

3. Unemployment has recently moved to 7.3%, up from 7% one year ago and 6.5% two years ago.
As economic activity increases (growth in Real GDP), unemployment rates fall, and as economic activity declines (fall-off in Real GDP), unemployment rates rise. The above unemployment rate of 7.3% compared with 7% one year ago and 6.6 % two years ago underscores both the difficulties in predicting when an economic acceleration will take hold and the need for fiscal and monetary policy actions designed to hasten that acceleration to return the economy to full employment.

The lack of job creation may have led to a marked decline in the growth of the labor force. Since fewer workers are competing for scarce jobs, this has the effect of preventing the unemployment rate from rising more quickly, masking the full extent of the underlying hardship.

The unemployment numbers above reveal the current weakness in the labor market, and its consequences. High unemployment rates lower the living standards of many working families. The persistent lack of job growth may lead to lengthening spells of unemployment and slower wage and income growth. The primary goal of domestic economic policy at this point should be to target and reverse these negative trends

4. The Federal Funds rate target is 3.5%, and the Discount rate is 3.25%.
The discount rate of 3.25% is the interest rate the Federal Reserve is charging banks if banks borrow reserves from the Federal Reserve itself. It is the only actual interest rate that the Federal Reserve sets. The target for the federal funds rate of 3.5% above was set by the Federal Reserve, but the rate itself is determined in markets. Banks seldom borrow reserves from the Federal Reserve and tend to rely more on borrowing reserves from other banks when they are needed. The discount rate is often changed along with the target for the federal funds rate, but the change does not have a very important effect.

The rates above follow the current government policy to be stimulative and encourage increases in spending and production. The Federal Reserve perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. With underlying inflation expected to be contained, the Federal Reserve believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Federal Reserve must have responded to changes in economic prospects to fulfill its obligation to maintain price stability.

Looks like while inflationary pressures were increased; expectations of increased inflation over time may have not changed. This means that the Federal Reserve expects to continue to increase the target for the federal funds rate again.

5. The Government budget has been operating at a deficit of approximately $60 billion for the last year, up from $50 billion the year before.
Based on the numbers above, the deficit has grown enormously. Some would say it’s a bad thing, and predict impending doom; others would say it is a safe and stable necessity to maintain a healthy economy.

This depreciation of the dollar counters the cost of the deficit but destroys the purchasing power of the dollar. Despite its dangers, inflation is used to some extent to curb the debt. Crowding out is when the government is looking for the same capital that the business sector wants to invest. This causes fierce competition for funds to invest and causes an increase in interest rates and often business will decide against further investment and growth. The government may have the money to build new highways but the truckers cannot afford trucks to use on them. The governments needs will “crowd out” business needs and in my opinion, turns potential assets into waste.

The dollar amount of the debt above may increase but so does the amount of money or GDP to pay for the debt. Seems like the deficit could be run without cost.

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