Review of the Current Macroeconomic Situation in the US - Essay Example

? The current macroeconomic situation in the US of Introduction The US economy has been passing through rough winds since the middle of 2007. The world saw some of the most impactful failures of financial institutions. Some of the leading banks and financial institutions based in the US have failed miserably during 2007 and 2008. Although the economy has crossed the period of turbulence, US economy is still growing at a slow pace. Signs of growth in economic activities within the economy are weak. One of the major reasons of concern for the US government is the high rate of unemployment prevalent in the economy (Federal Reserve). According to opinions of experts, it is undoubted that the economy is recovering, but at an unsatisfactory rate. This rate of growth is frustrating for the economists and policy makers in the economy, since such rates of growth are deemed insufficient for the economic progress of the country. In order to take the economy to higher levels of growth, economic performance by the country has to be boosted up. Different aspects of the economy have to be considered for the study of economic performance of the US economy. These aspects are represented by the variables, such as rate of inflation and unemployment and level of recession in the economy. Persistent weakness of the housing market in U.S. is one of the major concerns for the economy. At present, the US economy is characterized by tightening of credit conditions and availability of credit in different sectors in the economy, which is responsible for deleveraging of the U.S. households. The Federal government has adopted contractionary fiscal policies along with accommodative monetary policies. Considerable debates have arisen regarding the outlook of US Federal government in the short and medium-term. In this paper the current economic situation of the US economy is evaluated with respect to its fiscal and monetary policies of the Federal Reserve, the recessionary pressure on the government and the trends of other influential economic variables, such as unemployment, inflation and GDP growth of the economy. The issues arising from these policy prescriptions have been discussed with reference to government expenditure for maintaining social security system in the country and alternative policy solutions have also been presented in this paper. Unemployment situation in the US Young Americans are one of the worst sufferers of recession that has followed the global financial crisis of 2008. Although almost all open economies in the world have been affected at varying levels, research suggests that unemployment situation in America is grave. While other developed and developing economies have gradually been able to create employment opportunities for citizens, rate of unemployment in the USA for the age group of 16 years to 24 years is approximately 16.2 percent. This rate of unemployment is considered very high by policy makers in USA and also other countries across the globe. It has been apprehended that even if the rate of unemployment falls over the years, the impact of current unemployment would linger around for several years in the near future. Over the next ten years, members of the American labor force would experience a drop in total expected earnings by US $20 billion. Building on recent research reports published by Center for American Progress, economists have estimated that approximately US $22,000 per person has been lost in earnings (Ayres, 2013). This loss in earnings (depicted by fall in wages) holds serious economic implications for individuals, private corporations as well as the government. Higher unemployment would result in delay in repayment of student loans that would lead to ballooning of student-loan debt (Ayres, 2013). In the short term, the delay in repayment of debt would lead to loss in earnings by the financial institutions. These institutions would be unable to extend fresh debts, thereby, foregoing opportunities of higher earnings. Besides, the long term consequence of prevalence of unemployment for a long time span is that, individuals would be unable to make adequate savings for the future. Hence, future consumption is adversely affected (Dorfman, 2013). While unemployment in the current period leads to lack of aggregate demand in the economy, prolonged unemployment of the Millennials (young Americans of the current millennium) would lead to significant fall in aggregate demand in the economy in future (Dornbusch & Fischer, 2005). This would have a cyclical effect of low economic growth in the country. Low level of income would create low level of demand in the economy in future; low aggregate demand would suppress aggregate supply and eventually productive activities in the economy would decline. Hence, the economy experiences further lower levels of national income. Rate of job creation would further dampen. The following figure depicts that there has been fall in employment rate among the young Americans. Figure: 1: Employment to population ratio (Source: Ayres, 2013) Consumer price inflation in the US Rate of consumer price inflation in the United States is quite low. The credit crunch and the breakdown of the financial system within the economy have created strong recessionary pressure in the economy. Due to low national income and low aggregate demand in the economy, price inflating in the economy is quite low. Hence the Federal Reserve has decided to expand rate of inflation in the economy. Chairman Ben Bernanke of Federal Reserve has laid down that there is “no risk to inflation in the United States” (Shostak, 2013). In the current year, consumer price inflation is standing at a lower rate than expected and a long run objective of 2 percent has been set by the Federal Reserve (Federal Reserve, 2013a). Compared to consumer price inflation rate of 2.7 percent in March 2012, the rate fell to 1.5 percent in the second quarter of 2013. The Federal Reserve set an inflation target of 1.3 to 1.7 percent by the end of the current year (Shostak, 2013). The mandate prepared by the country’s central bank is “to pursue policies that will bring price stability i.e. a stable price level” (Shostak, 2013). The government has adopted various quantitative methods for making policy changes in order to achieve this goal. A stable 2 percent rate of inflation in the long run would signify consistency in the growth path of the economy. Significant deviation from the targeted figure reflects that the economy is not being able to maintain a strong growth (Hubbard, 2009). From the theory of dynamic aggregate demand (DAD), it can be predicted that if inflation in one period rises, it would push up the aggregate demand in the next period. This shift would be depicted by the natural increase in output in the economy. Shift in DAD would be by the same amount as change in natural level of output. The short run equation of dynamic aggregate demand is given by: Where, ‘?’ measures the interest-rate sensitivity of demand, rt measures the actual rate of interest, ‘?’ measures the natural rate of interest and € measures the demand shock experienced by the economy. The short run equilibrium between the dynamic aggregate demand and dynamic aggregate supply occurs at the point of intersection between the dynamic aggregate demand and aggregate supply curve. Figure2: Short run equilibrium (Source: Mankiw, n.d.) In the absence of demand shocks, if actual rate of interest matches the natural rate of interest, The demand shock is positive when consumption investment or government expenditure holds a greater value than the usual level or if tax rate is lesser than usual rate (Chiarella, Flaschel & Franke, 2010). Phillips curve The Phillips curve signifies negative relationship between unemployment and inflation. In the short run, consumers’ expectation regarding inflation is stable. Therefore, Philips curve holds true in the short run. When policymakers set a target of higher level of inflation that would decrease unemployment, consumers adapt their expectations to these policy changes very soon. Not only (Yt – Yt?) determines ?t, but Et-1 ?t is also another determinant of ?t. As Et-1 ?t rises, Phillips curve would move upwards and at a given (Yt – Yt?), higher inflation would prevail. However, in the classical model, tradeoff between inflation and unemployment does not hold in the long run. GDP growth Gross domestic product (GDP) of the US economy has grown at a faster rate than the expected level of growth. In the second quarter of 2013, GDP growth rate increased to 2.5 percent from 1.7 percent. In 2012, the country’s GDP was USD 15684.80, which is nearly 25 percent of the world economy (Trading economics, 2013). This shows that the country is slowly but steadily recovering from the effects of recession. Figure 3: GDP trends in the US (Source: Rampell, 2013) Recent reports indicate that this rate of growth has been driven by rise in overall consumer spending, exports, fixed investment for residential and non residential purposes. Residential investment shows the strongest signs of growth (Rampell, 2013). Monetary policies in the US Recent monetary changes have been made in the US with the goals of promoting maximum level of employment, bringing stability in general price level and making fixing long-term interest rates at a moderate level. By achieving these goals, the Federal Reserve would be able to support necessary conditions for boosting economic growth in the economy in the long run. Open market operations are the most commonly used monetary operation adopted in the United States (Federal Reserve, 2013c). Federal Open Market Committee (FOMC) Accommodative monetary policy The Federal Reserve has adopted certain monetary policy strategies that are driven by the dual purpose of achieving price stability and ensuring maximum level of employment. Due to the inadequate progress of the US job market, the Federal Open Market Committee (FOMC) has made efforts to make “additional policy accommodation” (Bernanke, 2013). Once the economy starts showing signs of recovery, the FOMC would adopt accommodative monetary policy for a considerably long period of time in future. The FOMC has decided to make additional asset purchases in the form of agency mortgage-backed securities (MBS) at the rate of US $40 billion per month (Potter, 2013). This purchase is expected to move beyond the stipulated monthly purchase of long-term Treasury securities of US $45 billion, which is made under the maturity extension program (MEP) (Potter, 2013). The FOMC would employ these apparatus of easy monetary policy, since it has been found necessary for bringing improvements in the labor market conditions as well as push the economy towards stability of price (Vietor & Weinzierl, 2012). These policies of asset purchase allow the FOMC to reach the desired level of flexibility in responding to economic necessities of the country. Hence, greater confidence regarding the government’s policies is installed in the view of the public. This further allows the government to achieve the desired level of inflation in the economy. Thus, the Federal Reserve is empowered to take actions necessary for promoting robust economic recovery coupled with price stability. Greater confidence in the economy leads to the creation of a transparent financial system. Under accommodative monetary policy, interest rates fall and investment activities rise. Therefore, marginal propensity to save (MPS) falls while marginal propensity to consume (MPC) rises. Since MPC+MPS equals 1, when MPC rises, MPS falls. Confidence in the economy promotes better economic activities and further job creation in the years to come. Since unemployment levels are still high and inflation rate is below the 2 percent target of the Federal Reserve, highly accommodative monetary policies have been adopted by the Federal Reserve in the current year 2013. Expansionary fiscal policy Increase in productivity needs involvement of increased amounts of physical capital (such as machineries, software or other equipment) and better quality of human capital. Using the capital efficiently leads to rise in productivity. In this context, the government plays an important role in the economy. The government provides public goods that directly contribute to the better living standard of the people thereby, leading to betterment of the entire economy. Government spending is directed towards improving the level of basic education of the population. In return, this process increases the level of human capital in the country. Spending made for development of infrastructure increases total physical capital in the country. The fiscal policy changes are made to improve incentive schemes for the employee and increase investment in the private sector, for making the pattern of use of physical capital and human resource base more efficient than it was before the global financial crisis occurred. However, some of the fiscal expenditures of the government include spending dedicated for health care facilities for the public, pensioners’ grants and miscellaneous other entitlements. In order to reduce budget deficit, the US government has reduced proportion of budget allocated for public health care and Medicare and pension facilities for the elderly population. It has been identified that these extra expenditures are not directly effective in enhancing competitiveness. However, these expenditures made by the government improve human capital in the country. Conclusion The discussion presented above shows that the one chief aspect that affects to healthy economic growth is stability in price level. When prices of the goods and services produced and consumed within the economy are stable, it conveys clear market signals to the producers about the price level, prevailing in the economy over a period of time, this would help businesses to determine the optimum level of resource allocation within the economy. This ensures efficiency in the usage of the scarce resources of the economy. It also leads to better economic outcomes. Therefore, it is quite obvious that the Federal Reserve aims at pursuing monetary and fiscal policies that would ultimately create price stability in the economy. Given high levels of unemployment and low rate of inflation (below target rate of 2 percent) the Federal Reserve has adopted highly accommodative monetary policies in the current year 2013. Policy of large scale asset purchases is aimed at sustaining downward pressure on the long term rates of interest that would support the mortgage and real estate markets (Federal Reserve, 2013b). 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