The State of Californias Quest for a Non-Deficit Economy - Essay Example

? Intermediate Macroeconomics Managing the Economy: August work: California’s Fiscal Rules The of California’s Quest for a Non Deficit Economy The economy of a state is one thing that plays a major role in the lives of the citizens. It is always important to ensure that there is a continuous effort to ensure that the economy is in the right state to get assurance that a state can sustain itself properly. Reliable report has it that the state of California has history of large budget deficits. The budgets are known to have created undesired effects to the livelihood of people and institutions in this state of the United States of America. There are many known causes of the successive deficits in the economy of the state of California. One of the known causes of the continuous deficits was a drop in the revenue of the state. For example, it is known that in the year 2008, the revenues of the state dropped by $15 billion which was gross. This decline was attributed to reduction in taxes such as personal, corporate among others. The other cause of the deficits in the economy of the state of California is connected to the state employees' salaries as well as benefits. The employees of the state of California have been experiencing growth of their salaries and benefits especially during times when economic boom occurs which has been creating a negative impact to the state's economy. The deficit in the economy of California is usually very sensitive since it forms a big part of the United States of America's economy. This forms a 13% of the USA's gross domestic product which is quite significant. This also affects the USA's gross state product to the tune of $1.9 trillion. This forms the biggest amount for one state as experienced in the year 2011. With the deficits in the state of California, this constitutes 30% of the entire deficit in the economy of the United States of America which is quite substantial.   Generally, it is the wish of all states and countries to have a balance in their economy. Assuming that the state of California adopts a constitution that there would be no budget deficit acceptable, many steps have to be taken by the authorities. The Mundell-Fleming model is one tool that can be utilized to show the effects of such a decision and what certain steps can result into. The Mundell-Fleming model is also known as the extension IS-LM model. The Mundell-Fleming model runs away from the IS-LM model through its trait of leaning towards an open economy setting unlike the IS-LM which addresses a closed economy (Asada 2003). This model incorporates nominal exchange rates, interest rates and output in the presentation of the short run relationship with an economy unlike the traditional IS-LM model which uses only the interest rates and the output. According to this Mundell Fleming model, for the state of California to achieve a no deficit budget, there is need to make some adjustments to some of the economical beliefs. The major thing that this model advocates for is that an economy cannot operate on fixed exchange rate, free capital investment as well as monetary policy which is independent. To operate on a deficit budget, the state has to ensure that the various aspects of the economy are operated in a more careful way. According to Argy (2013), the authorities have to ensure that GDP, consumption, physical investment, government spending, money supply, price level, interest rate, money demand and taxes are operated at adjusted levels. These are the variables which surround the Mundell Fleming model. I f the variables are kept at standard levels, the state of California will operate at a balanced or surplus budget. To achieve a balanced or no deficit budget, there is need for the authorities to ensure that the economy tries to operate at a level where the gross domestic product is equal to the total of consumption, investment, government spending and exports. This is one of the things that the IS factor advocates for which is the basis of the current Mundell Fleming model. There is also the need to ensure that there are higher interest rates or low gross domestic product so that the money demand may go down which is good for the economy to move towards stability. Applying the Mundell Fleming model, the components of the balance of payments should be operated at levels which bring a positive impact on the economy. This will occur where the factors affecting capital mobility lead to more mobility in capital in the state (Argy 2013) . This will be created by the difference between domestic and foreign interest rates during cash flows. Generally, there should be an effort to adjust the interest rates to a higher level which increases capital mobility in the state to positively serve the economy. Basically, the higher the capital mobility in an economy, the better for the economy since it makes things work positively. Changes in the money supply Working with the Mundell Fleming model, the state will see a positive effect in its economy through the changes in money supply. Looking at the model's graph, increased level of money moves the LM curve rightward. This specific movement lowers the domestic interest rate with comparison to the international interest rate. This action will definitely reduce the rate of exchange of the local currency through its capability to flow outside to enjoy the welcoming interest rate in foreign countries. This makes products in the local market more affordable compared to those from abroad. This makes the number of goods and services to foreign countries go high while imports decrease. According to the Mundell Fleming model, this will result in the decrease of the state's i local interest rates. In this scenario, the balance of payment is at zero since low interest  Increased government spending According to the Mundell Fleming model, the state of California can achieve the objective of operating with a non deficit budget if it plays around well with the government spending. According to this model, increased government spending causes a rise in the interest rates as well as the income also known as gross domestic product. Applying the model to show the effect of increased government spending, the IS curve shifts to the right. Basically, this act makes cash coming to the economy go up. Increased cash inflows make the currency prevailing in the local market has more weight than the foreign currency. This causes an increase in the number of imports compared to the exports. In the process, interest rates change which gets consistent with the balance of payments. Under this situation, the capital mobility will be good which translates into positive input into the economy. Therefore, for the state of California to operate at a balanced or surplus economy, it is vital to ensure that there is increased government spending. Impossible trinity This state in economy is also referred to as the trilemma. The impossible trinity advocates that it can not be possible for an economy t have a fixed exchange rate, free capital and independent monetary policy at the same time. This is ne thing that the state of California should avoid at the reports show that all the authorities which have tried to adopt the three factors at the same time have ended up failing economically. The underlying reason why the three factors re hard to adopt is because of the uncovered interest rate parity condition. This condition says that in situations where there is no risk premium, only arbitrage will operate. In this situation, arbitrage will make sure that the fall or rise of a countries currency in relation to another will be the same as the nominal interest rate differential rate separating them. In a situation where a country pegs the other, highest cost possible since it would result to the state losing the sovereign power of its money. This would be quite detrimental since it would create more crises in the state's economy thus creating more deficits eventually. The pegged state cannot have a monetary policy which is independent. There are very many reasons why the IS/LM expansionary policy has not been utilized in California. One of the reasons is that it is a very complex policy to crack. Experts and the general public find it hard to understand this policy. It is usually very complicated to apply thus the difficulty in implementation. Secondly, the fact that this IS/LM expansionary policy assumes that there are no free prices is very backward. It is challenged by the fact that most modern models are in belief that the prices, rates as well as the markets are complex. The other reason for the restriction of use of this model in the state of California is the fact that this model ignores the effect of supply in an economy. Lastly, this model fails in the fact that it does not address the state of economy in the long run (Argy, 2013). This means that planning as well as forecast which is a major component of economy can not take place thus an eminent risk of failure if this model is implemented. There are other many policies that the state of California can utilize to ensure that they operate on a non deficit budget. These include all means including the use of the banks to stimulate the state’s economy. These policies may either be contractionary or expansionary to indirectly target a particular rate of interest for the purpose of maintaining stability and stimulating economic output. As a typical example, an expansionary policy using an interest rate tool would be used to reduce the rate of interest, making credit less costly and less rewarding for savers, thereby increasing the amount of money in the economy. A contractionary policy, on the other hand, makes it more expensive to borrow and rewards savers, thereby reducing the money supply and slowing inflation. This measure would be utilized as and when they became necessary in order to ensure a 'desirable' level of prices, unemployment, and consumer spending. There are other tools available to the Bank as well which is perhaps a little more direct, but the most well understood method is the aforementioned manipulation of the interest rate to indirectly affect inflation. So what happens when the Central Bank interest rate is as low it can be and the economy is still contracting? While the efficacy of using 'conventional measures' such as the power to change the base rate of the Bank is well established, other measures, such as a direct expansion of the money supply by purchasing financial assets, are less well understood and the long term effect of the use of such instruments is even less so (Asada, 2003). Monetary policy is also another main process that can be used to bring a positive state in the economy of California. Monetary policy is a globally accepted process of managing economies. It is a process through which the concerned authority of a country in question puts control on the issuance of money. Monetary policy basically focuses on the interest rate to ensure that the economy of the country grows as well as create its stability (Asada 2003). Some of the indicators of a successful monetary policy are the presence of prices which experience no major movements as well as high levels of employment. The application of monetary policy will lead to certain positive impacts in the economy of the state of California. Since California is a developed state, monetary policy will be able to Stabilize prices, adopting full employment and stability of exchange. There are also more roles that monetary policy will play in improving the economy of the state of California. One of these vital roles of a monetary policy in a country is that of a development tool (Argy, 2013). A monetary policy in a country can be very pivotal in influencing the rate at which the economy of a given country grows. This is by its positive impact on things such as supply, inflation control, credit use as well as maintenances of balance of payment. This is usually supported by the monetary policy helping in expanding trade as well as making credit available. Secondly, monetary policy will ensure that financial institutions are brought to existence and expand operate on a non deficit budget. This means that institutions such as banks, micro finances and saving and credit co-operative societies will grow and expand in the country if the monetary policy is functional. This means that people will be able to obtain loans as well as other monetary services from these institutions. This is usually a sure way of ensuring that the economy of the state grows to the required standards. Monetary policy always ensures that the funds of a financial institution are channeled to the key sectors in the state such as trade and industrialization depending on the countries plan. Monetary policy also ensures that a country develops and maintains a central banking system. This is through playing a major role in controlling and keeping an eye on the amount of credit in a country. This is always through keeping check on the interest rates among other means. With monetary policy controlling credit, resources will be allocated properly with all funds getting utilized in productive areas in the economy. According to Argy (2013), monetary policy also integrates the organized and unorganized money market. This mostly occurs in the economies developing countries since there are dual forms of money markets. Since the counties money regulator, central bank regulates the organized money market; the monetary authority takes the responsibility of linking the unorganized money market to it since it is not under the central banks scope. Managing debt is also another important thing that the monetary policy of a country does. So that the debt may be well managed, government bonds should be issued at the appropriate time, prices should be put in a stable level and cost of the various debt instruments should be reduced significantly. This is always possible through ensuring that the debt rates are available to those operating in a specific economy. It is worth noting that the success of monetary policy in this role is dependant on the state of money and capital market. With proper created and developed markets, debt management will be successful through use of monetary policy. Monetary policy also ensures that the rural credit system in a country reforms. Most of the time, this form of credit system is usually lacking especially in underdeveloped countries (Argy 2013). Due to the deficiency in the rural credit system, the local farmers and village traders are usually exploited by those who usually offer loans to them such as local wealthy leaders. According to Asada (2003), with a good monetary policy in a country, these people are usually provided with affordable credit facility which assists them in their efforts to create wealth. The monetary policy does this through creating provisions which promote the creation of co-operative credit societies as well as banks which are inclined to agricultural activities. There are also countries where there are notable traces of sector which do not utilize money in their activities. Under such circumstances monetary policy helps in monetizing the sectors. It helps in creating systems which ensure that transactions are monetized thus doing away with traces of barter exchanges (Asada, 2003). The monetary policy also ensures that after monetization, the system grows consistently. Monetary policy will also assist in avoiding imbalances in the balance of payments of the state. Specifically there is an important policy that can assist the state of California is the quantitative easing. Quantitative easing is a monetary policy by the government which is used in increasing the money in circulation. It is usually aimed at increasing the banks’ ability to lend and stay liquid. For quantitative easing to be effective, the central bank has to set short term interest rate at 0 percent, give duration for the 0 percent interest rate and buy long term instruments. This policy is usually used by central banks whenever lowering of interest rates does not deliver as per the objectives set out by the countries’ monetary authorities (Argy, 2013). With the central bank applying quantitative easing as a monetary policy, the banks as well as other financial institutions will be able to increase the amount of its reserves. This will lead to ease in the process of lending since there will be need for borrowers due to a lot of money being available. Quantitative easing usually makes it easier for people as well as businesses to get loans they require. With quantitative easing, the economy is usually triggered towards positive movements since spending is usually resumed. This will ensure that the economy of the state of California moves in the right direction. Monetary policies always increases spending as well as investment due to the low interest rates associated with it. This contributes to recovery of the economy due to the increased spending as well as investment in a country. Investment is encouraged due to the low costs of borrowing money from banks and other financial institutions operating in a country. Things like mortgage cost reduce thus leading to an increase in spending power of the specific homeowners. Fiscal policy is also useful during the recession period in a country. Fiscal policy basically addresses the action of utilizing in the power of low tax rates and high government spending (Asada, 2003). This is always aimed at boosting overall demand and raising growth in economy. It is unfortunate that the state of California cannot implement monetary policy since it is not a state. This is because the monetary policy is only authorized and implemented under the authority of the Federal Reserve. It is worth noting that the Federal Reserve is the only organ allowed to determine and put into practice all monetary policies in the United States of America. It is very hard for an independent state such as California to make a decision regarding monetary policies by itself. This brings forward the challenge of missed opportunities since the countries monetary policy decision making organ may fail to realize certain policies which would have been beneficial for a state such as California. In conclusion, it is always important for all those involved in plans in all monetary authorities in the state of California to be keen when choosing the right policy and model. It is necessary to choose the right policies for the state of economy prevailing at a given time. The officers in the monetary authority dockets should not shy away from consulting more experienced experts in this sensitive field of economy. This will ensure that the best decisions are made which helps in ensuring that the economy benefits the players in a given economy. There is also need for the state’s monetary authority to look at other economies in the world and see how they work. This will make sure that the best economic practices are picked and incorporated in a county’s economic system. It is worth noting that comparison should only be done with similar and better economies in the world. There should be a team set aside to ensure that the best combination of policies is put in place in the planning of the economy in the state of California. This will ensure that only positive results are obtained capable of moving the budget above deficit level which is desired. References Asada, T., 2003, Open Economy Macrodynamics: An Integrated Disequilibrium Approach: Springer. Argy, V., 2013, International Macroeconomics: Theory and Policy: Routledge. Read More