The US Financial and Monetary Policies - Case Study Example

Have U.S. financial and monetary policies since 1979 strengthened America’s position in the global economy? Introduction Besides regulating the activities of the specific industries in the economy, the American government also controls the overall speed of economic activity, with the general aim of maintaining price stability and high levels of employment (Portes, 2009). The government applies two tools to attain these objectives, the monetary policy through which the supply of money is controlled, and the fiscal policy through which appropriate levels of spending and taxes are determined (Borio & William, 2004). Much of the economic policy history in the United States from the period of the Great Depression has involved the governments continued effort to determine the appropriate mix of the monetary and the fiscal policies that will enhance price stability and sustained growth. However, this has been a difficult task since there have been notable failures in the long run. In this essay therefore, we provide an analysis of the U.S. financial and monetary policies since 1979 and determine if these policies have strengthened America’s position in the global economy. A brief overview of the American economy From 1854 to 1919, the American economy was mostly involved in contracting and growing, since the average economic expansion lasted for about 27 months whereas the economic recession lasted for almost 22 months. The period from 1919 to1945 saw the country’s economy expand as the average expansion lasted for about 35 months, while the recession lasted for only 18 months. From 1945 to 1991, the economy even got better since the expansion lasted for about 50 months while the recession lasted for only 11 months. From then the rate of inflation in the American economy has proved to be more intractable (U.S. Department of State, par, 4). For instance, the prices remained stable prior to the Second World War since the consumer price level in the 1940s was almost similar to the price level in 1778. However, in the 1980s the price level was estimated at 400 per cent higher than the 1940 price level (Taylor, 2009). In 1979, the government started paying attention to inflation, an effort that has sought to strengthen America’s position in the global economy. For instance, in the 1990s the country had a gratifying combination of low unemployment, slow inflation and strong economic growth (Schmitt-Grohe, & Uribe, 2006). America’s fiscal policies and their effects on economy After the Great Depression, the government started to apply fiscal policy in promoting the country’s economic growth and stability. An English economist, John Keynes using the General theory of employment, interest and money, which states that the high unemployment rates resulted from insufficient demand for the goods and the services, influenced this initiative (Caballero, et al. 2008b). Keynes argument was that people lacked enough funds to purchase everything that was being purchased in the country, and therefore the companies’ response was to lower prices, which in turn made them go bankrupt. The government was needed to respond by cutting on the taxes or increasing spending, an idea that was confirmed true during the increased military spending during the Second World War (U.S. Department of State). Nonetheless, the country recognized the goal of fiscal policy as that of reducing deficits. For instance, foreign trade opportunities were rapidly expanding in the 1980s, while technology was spinning off new products, and thus there was no much effort required from the government policies since growth was inevitable. Instead, the government considered lowering its deficits as a strategy to minimize government borrowing and lower interest rates (Bernanke, 2005). This would in turn make it easier for businesses to obtain capital that would finance expansion. Policy makers in the 1990s realized that applying fiscal policy to attain broad economic goals was ineffective, but they instead focused on smaller policy changes that would strengthen the country’s economy. For instance, policy makers decided to minimize taxes on capital gains in order to increase incentives to invest and save. However, this change appeared controversial since some people saw it as being beneficial to the rich only. In effect various job training and education programs were introduced that would produce a highly skilled labour force. However, the fiscal policy considers three areas, employment, taxes and interest rates. The fiscal policy introduced in America has indeed boost the country’s economy as it currently considered as one of the countries with the leading economy on a global scale. For instance, the country has concentrated on obtaining a highly skilled task force, which has in turn made the country more productive and competitive. It has also created more employment opportunities for its citizens to ensure people have income to purchase products manufactured in the country. America today enjoys high inflation rates with high employment rates, which have all worked to make the country’s economy stable. It is therefore true that the United States’ financial and monetary policies have strengthened America’s position in the global economy. Monetary policies and their effects on the global economy Monetary policy is the process through which a country’s monetary authority that includes the currency board, central bank and other regulatory committee controls money supply by determining its rate of growth and size (Bordo, 2008). This usually targets interest rates, or, and bank reserves, with an intention of promoting stability and economic growth. The official objectives of monetary policies are to maintain low unemployment rates and stable prices. In the United States, monetary policy is left in the hands of the Federal Reserve (Bernanke, 2006). The United States government endeavors to control the economy through monetary policy. Inflation rates increases when the money supply grows at a higher rate, whilst, slow economic growth is experienced when the money supply is regulated or slowed too much. The Federal Reserve uses various tools to control money supply and credit in the United States economy (Monetary Policy, 2006). One of the main tools is open market operations. This involves buying and selling of government securities to businesses, banks and the general public in order to increase or reduce the supply of money in the economy. For instance, to increase the amount of money in circulation (money supply), the Federal Reserve usually buys government securities from businesses and banks and pays for them using checks (new money) which creates new reserves which can be invested or lend to individuals (Nelson, 2007). In contrast, to reduce the money supply, the Federal Reserve usually sells government securities to the banks and collects reserves from them. Reduced reserves imply reduced lending thus, reduced money supply. The second tool used by Federal Reserve to control money supply is discount rate. By lowering or raising discount rates, borrowing can be promoted or discouraged thus, altering the amount of money available to commercial banks for lending (Mark, 2007). Low interest rates imply that, businesses can be able to borrow and invest in various projects which promote economic growth. Low interest rates also encourage banks to lend, thus increasing spending. In the short run, lower interest rates are connected with increased aggregate demand due to reduced foreign exchange value of dollar (Mark, 2007). Due to this, U.S firms have increased their production and employment levels, which as a result augment business spending on commodities. The increased levels of economic output also increases consumption levels of consumers. Lastly, reserve requirement is also used to regulate money supply. Raising the reserve requirements means that, banks have to hold much money which reduces amount of money in circulation, whereas, lowering reserve requirements means that, banks have much money to lend which increases money supply (Nelson, 2007). These monetary policy tools have been used by the Federal Reserve for a long time in stabilizing the United States economy. It is true that, since 1979 to the current time, these monetary policy tools have helped America to strengthen its position in the world economy. For instance, due to the increased rates of inflation in 1970s, the central bank in 1979 tightened the monetary policies. This policy as a result helped in slowing down money supply growth; nevertheless, it assisted trigger sharp recessions in 1980 and 1981-1982 (Rorabaugh et al., 2004). The policy also assisted in reducing inflation rate, whilst the interest rates gradually came down, the deficit level narrowed and eventually disappeared in 1990s (Nelson, 2007). Therefore, monetary policy in this case assisted in fighting the increased rate of inflation. Generally, the United States maintains a steady inflation rate of 2 percent to 3 percent. Inflation has major negative impacts in all economies. For instance, high inflation rates hurt individuals with fixed incomes due to increased relative prices of goods. In addition, financial institutions, banks and savers are also affected by high inflation rates. Anticipated inflation leads to decrease in the value of money in terms of the amount of goods to buy, while loans are paid back with worthless dollars (Monetary Policy, 2006). Therefore, the utilization of monetary policy by the Federal Reserve to control money supply has assisted greatly in controlling the rates of inflation thus, stabilizing the US economy. Currently, the United States is ranked position four, from first position in 2008-2009 as a result of the economic crisis, in the Global Competitiveness Report. America is one of the globes largest and most powerful financial markets, home to key commodities and stock exchanges (Maddison, 2006). Conclusion In conclusion, the financial and monetary policies used by the United States since 1979 have assisted in strengthening America’s position in the global economy. The monetary policy tools employed by the Federal Reserve which include open market operations, discount rates and reserve requirements; and the fiscal policy tools which comprise of taxation and government spending have helped America greatly in promoting economic growth, maintaining low unemployment rates and stable prices. In particular, these policies has assisted U.S in maintaining its inflation rates at low levels, which has assisted in boosting bank lending, therefore amplified investments in capital good References Bernanke, B, 2006. 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