Assessment of the Current Economic Condition in the USA - Research Paper Example

Introduction The current economic crisis is considered as one of the most critical in the modern history of US. Apparently the crisis started when the subprime mortgage bubble started to burst however, its underlying consequences were much severe as it started to engulf whole of the economy and as such the overall economic situation of the country started to worsen. What is also significant to understand that that the current economic crisis has also exposed the inherent weaknesses of the financial system of the country and as such there is a great need to take efforts which can effectively ensure that the financial system of the country is not de-railed and institutions are proactively managed with focus on controlling their overall risk appetite. During last two years employment level in the country continuously declined and as such the pace of economic growth has slowed down. As such the overall role of FED becomes relatively more critical because of the monetary policy regulator of the country. A critical assessment of the overall economic situation of the country is therefore of critical importance as it will allow a better policy formulation as well as provide a broader understanding of how the different variables are acting together to create this sort of economic crisis. The basic purpose of this report is to assess the overall economic conditions of the country, an assessment of the steps undertaken by FED so far and to produce set of policy recommendations which may be considered by FOMC in its next meeting. Economic Assessment In order to discuss and assess the current status of the economy, it is important that the background information must also be provided in order to assess the core issues faced currently faced by the US economy. During 2008, Bureau of Economic Research publically announced that the US economy is in deep recession. This announcement was just a mere acknowledgement of the fact that the country’s economy was already under a threat from going into the recession and probably depression also. If one attempts to trace the origins of the current economic crisis, it will emerge that the situation started to get worse when financial sector as a whole was gradually de-regulated by the authorities. The de-regulation of the financial sector allowed banks and other financial institutions to engage into the practices which were relatively risky for the long term survival of the firms. As such the focus was on the achievement of short term results rather than ensuring that the long term stability is achieved. Such practices therefore led to the systematic collapse of the financial institutions of the country and the world also and as such the overall contagion effect started to take its roots in the economy. As a result of this contagion affect, other macroeconomic variables such as employment and growth were hampered too and government along with FED has to jump in order to save the economy as well as financial system from complete collapse. Following sections will discuss and provide a crucial assessment of the current economic situation of the country. Unemployment Level One of the most important economic variables which caused much debate and concern in American society was the unemployment level. Some estimates indicate that the unemployment level rose to double digits during 2008-2009 and crossed 10% limits. However, the unemployment levels reduced to 9.7% in April 2010 with consistent increase in the factory payroll levels. (Homan). Such high level of unemployment therefore created relatively higher claims for unemployment benefits. Further, such high unemployment level also created low labor demand because of the reduced factory level and manufacturing activities. The high level of employment therefore tends to have more impact on the manufacturing activity within the economy. The low level of manufacturing activity therefore further resulted into the slow down of the growth too. Economic Growth Economic growth during 2009 was negative as high unemployment levels, low credit extension to consumers and fears resulted into low aggregate demand. The current estimates suggest that the economy grew at a rate of 3.2% in the first quarter. (Amaral). During the last quarter of year 2008, US economy witnessed negative growth rate of 2.7% which continued during 2009 also and the GDP Growth rate went on to hit negative high of 6.4% during the year. 1 It is also important to note that during the recessions, many large and small financial and non-financial institutions either went out of the business or were declared bankrupt. Most importantly, organizations like Lehman Brothers and Ford were declared bankrupt whereas other institutions like AIG, Finnie Maie received large government support to sustain them. Interest Rates As a result of the high unemployment level and negative growth, the overall interest rates in US were almost down to zero. FED, in order to cope with the situation went on to reduce the interest rates to a large extent in order to stimulate the consumer spending as well as reducing the burden on high mortgage payments on the consumers. It is however, important to note that the interest rate cuts were gradual in nature as interest rates were 6% at the beginning of 2009 which were gradually reduced by the FED during 2009 and almost touched zero.2 One of the reasons as to why the interest rates were lowered is based on the fact that overall consumer spending was low due to which the manufacturing activity was declining. Declining manufacturing activity therefore in fact was adding to the unemployment level of the economy. Inflation Rate It is critical to note that despite having very low interest rates, the overall inflation level remained very low during the period. Economic theory suggest that low level of interest rates result into consistent increase in the inflation however, during the period, the inflation level also remained negative during most of 2009. Highest recorded inflation rate during 2009 touched the figure of 2.1% during the last quarter of 2009 otherwise for most part of 2009, inflation rates remained negative.3 Low of inflation however, can also be attributed to the fact that the firms were just willing to encourage the consumer spending activity in order to generate growth at the cost of low or declining prices even. Steps taken by FED The current financial crisis proved as the most important challenge for the central bank of the country to not only pull the country out of its current economic collapse but also save the world financial system from complete collapse. The task of FED therefore was relatively challenging one as it required a comprehensive understanding of the important macro-economic variables and how to control them in order to achieve the desired policy objectives. In order to overcome the current economic crisis, FED has undertaken many important initiatives in order to achieve stability in the economy. Some of the actions were direct intervention into the market affairs whereas some of the steps taken were indirect and were aimed at stabilizing the economy without intervening directly into the market. It is also important to note that current economic crisis has also forced FED to undertake actions which a central bank normally does not take. However, the bailout plan that has been given is also criticized because many now argue that it was an attempt to save the riches at the cost of tax payers money and as such the steps taken at the fiscal as well as monetary policy levels were actually taken in order to secure the interest of the few who are often viewed as the main proponents of the current economic situation due to their imprudent business policies and actions. Some of the actions taken by FED are: Quantitative Easing Quantitative easing was one of the steps that FED taken in order to achieve its objectives of economic stability and growth. Quantitative easing is done when central bank cannot effectively reduce the discount rate however, it still attempt to reduce the interest rates by purchasing the government and corporate bonds from open market. The overall idea is basically to increase the money supply in the economy by purchasing the bonds and increasing the currency in circulation. FED was instrumental in quantitative easing as it went on force interest rates to touch almost zero level. What FED effectively did was to increase the money supply in the economy not through printing new money but by creating artificial money through electronic transfers. It is also important to note that the impact of quantitative easing is relatively hard to measure and historically central banks including Bank of England have to retract from this strategy. Target Relaxation It is generally believed that with the decrease in the interest rates, inflation often creep up therefore the overall aim of increasing the money supply in the economy has to balance the inflationary targets in the economy too. However, FED went to take a very unique approach in this regard by further relaxing the monetary targets in a bid to increase the aggregate demand. The overall focus was on the increase of aggregate demand rather than increasing the money supply therefore by further reducing the monetary targets, FED attempted to stimulate the aggregate demand. Target relaxation also seems to work because they did not create the relative reactions from other stakeholders in the economy. FED through the purchase of corporate bonds as well as government bonds from open market actually attempted to provide more money to the market not only to stimulate the manufacturing activity but also improve upon the confidence of the consumers to start consuming again. Interest Rate Reduction Another important step taken by FED was the drastic reduction into the interest rates in the economy. As discussed above that the overall aim of FED was to bring the interest rates to zero. To achieve this objective, FED reduced policy rate to a great extent and targeted the range of 0 to 0.25% for the policy rate. During 2008, interest rates were reduce to 1% which were further reduced to almost zero percent in order to further ease the economy and stimulate the growth and aggregate demand. It is also important to note that the drastic reduction into the interest rates were relatively more aggressive as against such efforts taken by other central banks. Drastic and aggressive reduction into interest rates was therefore basically aimed at stimulating the economy at the cost of higher money supply. Traditional Tools During the crisis, FED has also used its traditional methods such as reduction in the discount rates as well as the aggressive open market operations. These actions or tools however, were taken in conjunction with the other tools described above. Recommendations The above discussion therefore leads us to the set of recommendations that may be considered by FOMC. These are: Reduction in quantitative easing The assessment of the affects of the quantitative easing are hard to measure it is therefore recommended that the FED should start to consider the retraction of this practice. Since economic indicators are now showing improved signs therefore it is more important that the next round of reforms and efforts shall be based on consolidating the gains of earlier actions rather than continuing the earlier actions. A gradual withdrawal of this will allow the economy to return to its natural outcome and increase the level interest rates in the economy to a sustainable level. Increase in interest rates Since manufacturing activity is picking up now and consumer activity is healthy too. In such scenario, negative inflation can actually result into deflation which can further put the country into deep troubles like currently experienced by Japan. In order to ensure that the prices do not go down beyond a level where it is unprofitable for the firms to produce, it is critical that a gradual increase in interest rates must be ensured. FED can do so by increasing either the policy rate or changing the yield on the T- Bills. It is assumed that with the consistent and slow increase in interest rates, inflation will reach to a sustainable and positive level wherein it can be beneficial for the economy as a whole. Bibliography 1. Amaral, Pedro. "The Recovery So Far." 2010. Federal Reserve Bank of Clevland. 20 May 2010 . 2. Homan, Timothy R. "Unemployment Rate in U.S. Falls to 9.7%; Factory Payrolls Grow." 2010. Business Week. 20 May 2010 . Read More