The Issue of Price Stability and Its Impact on the Economy - Term Paper Example

? Macroeconomics and The paper takes into consideration the branch of economics referred to as macroeconomics. Macroeconomics just like microeconomics is an important concept in economics because it has various important concepts that are essential for economic wellbeing of any country. Macroeconomics has critical elements, which include price stability, equilibrium in balance of payment, economic growth, and employment. It is the central role of any government to ensure that the economy of the country is which it is run has favorable economic policies by use of various fiscal or monetary policies. The paper concentrates on the issue of price stability and its impact to the economy Introduction Price stability refers to a situation in which the prices of goods and services in a country over a given period of time remains. It can also be best described as time when the retail index price is constant. The opposite of price stability is referred to as inflation. Inflation is an adverse macroeconomic element that is not acceptable in the economy. It is characterized by the unprecedented increase in prices of goods and services that results to making the cost of living to sour up beyond the purchasing power of various household (Pierson 20). It is the central role of the government of the day to ensure that only some small inflation, popularly referred to as mild inflation, is experienced in the society. When the level of inflation increases, it is a bad indication, which shows that the cost of living of the household has increased. When the cost of living goes up, the lower-class households are the worst hit. However, it is good to take note that some level of inflation in the economy is acceptable as it shows that there is some form of economic growth in the country Discussion It is every government’s responsibility to attain positive macroeconomic elements in the economy, and USA government is no exception. The United States has always strived to ensure that there is low inflation, low unemployment levels, high rate of economic of economic growth, and equilibrium in balance of payment. The subsequent paragraphs concentrates on the efforts and measures put in place by the United States’ government to tackle inflation. Notably, inflation takes various forms, which include wage inflation, cost-push inflation, sectorial inflation, demand-pull, and pricing power inflation. Demand-pull is a type of inflation that is caused by excess demand of good and services in the economy, which causes the prices of goods and services to increase. On the other hand, cost-push is a form of inflation that is caused by increased cost of production. Such increased cost of production compels producers to pass the cost to consumers in terms of high prices (Pierson 20). On the other hand, wage inflation occurs when people are paid more salary, hence causing their disposable income to increase. With increase in disposal income, the increase in purchasing power is inevitable. The consumers tend to spend more in such circumstance leading to increase in the prices of goods and services. Essentially, there exists several level of inflation, which includes mild inflation, moderate inflation, hyperinflation, and stagflation. Mild inflation is good for an economy; in fact, this is the primary objective of the USA’s government, since it is mandated to maintain a low inflation rate of not more than 3 percent (Mills 112). Maintaining low inflation is a tasking procedure, which requires balancing of many and complex macroeconomic policies. Inflation is measured as a yearly rate of change in the retail price index. In order to achieve price stability, the rate of inflation should be maintained at zero. This is only theoretical and cannot be practical in the real economy. Some level of inflation is good for the economy as it signifies growth in the economic performance besides showing that owners of factors of production are being rewarded for their investment efforts. Mills argues that the United States has had elaborate strategies to counter high inflation. The strategy targets the underlying rate of inflation (112). This strategy is justified because, besides helping to control the level of inflation, it is also instrumental in checking the interest rate and the retail price index. In a bid to maintain low level of inflation, the United States’ government has to contend with the unemployment in the economy. Currently, the rate of unemployment in the United States stands at 7% while the inflation rate is 2.7% (Mills, 112). This rate of unemployment is not badly off as it shows that the United States’ economy is at near full employment. High unemployment levels have adverse social and economic cost to the economy. Unemployed people have low purchasing power, hence their rate of consumption is low (Gordon 220). The other characteristic of unemployed is that they lose their skills and morale with time; hence, they become less productive in the economy. The government is obliged to incur extra public expenditure to provide social benefits to the unemployed population. Finally, the adverse effect of high employment rate is that it results in increased cases of social evils such as crime, prostitution, and vandalism. In a bid to cushion the economy from inflation, the United States government permits some level of inflation in the economy. The Concept of Philips Curve in Inflation Striking a balance between inflation and unemployment brings about the concept of Philips curve. Philips curve suggest that there exists a tradeoff between inflation and unemployment. As the United States government tries to thwart inflation, the rate of unemployment also goes up as shown in the diagram below (figure 1). This is so because the two macroeconomic elements have opposing fiscal and monetary policies that are used to fight them. Inflation requires contractionary economic policies while unemployment requires expansionary fiscal policies. During high inflation, the government is forced to reduce public expenditure and increase the interest rate to reduce the money supply in the economy consequently resulting to low inflation levels. However, when the government reduces the amount of public expenditure or the interest rate, the level of employment will go down .This opposing tendency between inflation and unemployment compels the government to strike a balance by ensuring that their exists some level of inflation and unemployment in the economy (Gandolfo, 251). The most practical level of inflation and unemployment should be 3%; this scenario will show that the economy is at near full employment, and the prices of goods and services are stable judging by the consumer index price. Figure 1: The Philips Curve In discussing inflation in the USA, the issue of economic growth cannot be overlooked. Economic growth is measurable in terms of the rate of change in the GDP (Gross Domestic Product). The use of the word real signifies that the effect of inflation on the economic growth of the USA has been removed (Friedman 123). In the year 1999, the United States GDP growth registered a rate of 1.8%. This is low level of inflation by any standards and it can be attributed to the economic downturn that had greeted the economy at that time. During such period, the rate of inflation in the economy is usually high. In fact, in the same year, the rate of inflation in the US was at 7% (Gandolfo, 251). The bank of America is responsible for ensuring that United States economy attains sound macroeconomic levels in terms of price stability, full employment, economic growth and equilibrium in the balance of payment. In order to attain this, the bank has in place a raft of monetary and fiscal policies that they use to attain their macro-economic objective. The US government targets an inflation rate of 2.0%. This inflation rate is well balanced with the unemployment level, which is pegged at 3%. Friedman (123) says that currently, the unemployment level is at 7% and the inflation rate in United States is at 2.7%. This level falls way below the target set by the government as inflation target rate and unemployment target rate respectively. The various policyholders in the economy should aggressively implement the various monetary and fiscal policies to ensure that the economy of United States attains this target. Attainment of these objectives goes a long way to ensure that the social and economic costs on the government are reduced significantly. Relationship between recession and Price Stability It is worth noting that during recession the rate of inflation increases. Recession refers to a business cycle characterized by contraction of the Gross Domestic Product levels. This is always evident in the reduction in production, decline in employment, and decline in the levels of investment in the economy. Currently US economy is not in recession because in the third quarter of 2012 the economy expanded by 2.7% as compared to second quarter and third quarter where it expanded by 2% and 1.3% respectively (World Bank, 211). The United States is one of the strongest economies in the world because of diversification and technology. The economy has several vibrant sectors such as service sector, which comprises of banking sector, insurance sector, and real estate. According to World Bank (211) these sectors accounts for about 40% of GDP (gross domestic product). The wholesale and retail sector is equally large and accounts for up to 12% of gross domestic product. Other sectors include manufacturing and agriculture in which agricultural sector accounts for 1.5% while manufacturing comprises of 17% of the GDP. The US government also contributes a sizeable share of gross domestic product, which stands at 13%. US government experienced huge recession between 2008 and 2010 in which the economy contracted to as low as 8.9% but the economy has been able to recover thanks to the vibrant sectors. Challenges in measuring price stability Gross Domestic Product is a good measure because it gives economist direction on how the country’s economy is fairing. It puts to perspective various macroeconomic elements such as price stability, balance of payment, and employment. Gross Domestic Product shows how much an economy is producing as well as calculation of Gross Domestic Product per capita. It is possible to calculate the Gross Domestic Product per capita because the population of a nation is always known. Despite the merits of Gross Domestic Product as a measure of economy’s well-being, it has some limitations discussed below, Gross Domestic Product does not consider valuable non-market transactions like subsistence production by households as well as volunteer services (Pierson 154). There is always a lot of productions at a subsistence level by households and the government should collect data on such production and include them in computation of Gross Domestic Product. Almost all economies in the world have underground economy with a sizeable production. The productions in underground economy are always not included in the calculation of Gross Domestic Product because the government does not have adequate data on their activities. Lack of inclusion of underground economy in computation of Gross Domestic Product underestimates the economy’s income. The underground economy comprises of unlawful trading and tax evasion activities. The comparison of nations well-being by use of Gross Domestic Product is not accurate because off several differences amongst economies. For instance, Gross Domestic Product fails to take into consideration the differences in exchange rates. Additionally, most countries are at different level of economy development. Developed countries produce capital and processed goods whereas undeveloped countries produce mainly unprocessed goods such as raw material, therefore, comparison between these two economies is not logical since Gross Domestic Product does not take into consideration these differences in Gross Domestic Product statistics. Conclusion Macroeconomics has critical elements, which include price stability, equilibrium in balance of payment, economic growth, and employment. It is the central role of any government to ensure that the economy of the country is which they run has favorable economic policies by use of various fiscal or monetary policies. Price stability refers to the situation in which the prices of goods and services in the country over given period of time remains. Inflation is an adverse macroeconomic element that is not acceptable in the economy. It is characterized by the unprecedented increase in prices of goods and services, which makes the cost of living to sour up beyond the purchasing power of various household. When the levels of inflation soars up it is a bad indication, which shows that the cost of living of the household has gone. When the cost of living goes up those on the receiving end are the lower class households; however, it is good to take note that some level of inflation in the society is acceptable as it shows that there is some form of economic growth in the country. Works Cited Friedman, Benjamin M. The Moral Consequences of Economic Growth. New York: Knopf, 2005. Print. Gandolfo, Giancarlo. Elements of International Economics. Berlin: Springer, 2004. Print. Gordon, Robert A. The Goal of Full Employment. New York: Wiley, 2007. Print. Mills, Frederick C. Prices in Reccession and Recovery. New York: NBER, 2006. Print. Pierson, John H. G. Full Employment. New Haven: Yale University Press, 2001. Print. World Bank. World Development Indicators 2011. World Bank , 2011. Print. Read More