Moderation in Intervention - Assignment Example

Economics Essays It is essential for the government to moderate business cycles. Moderation in intervention is essential to not worsen the next phase of the cycle. The three greatest dangers associated with the boom-bust nature of the business cycle are inflation, deflation and unemployment. It is to protect against these that intervention is necessary, but simultaneously must be moderated. First, I will explain dangers to an economy that inflation, deflation and unemployment present, then why intervention must be calibrated properly. Inflation, which usually occurs during the expansionary phase of the business cycle, is a general increase in the price of goods and services. While low levels of inflation are manageable, higher levels can wreck havoc on an economy. Inflation at any level acts as an invisible tax on savers. Any money saved is capable of purchasing less goods and services. This harms vulnerable groups such as senior citizens who rely on savings more heavily than other groups. It also provides a disincentive to save. Also if growth is too rapid it can risk a shock to the system by bursting an economic bubble, like the tech bubble of the nineteen nineties or the recent housing bubble. Deflation and unemployment are the dangers of the recessionary side of the business cycle. Deflation is a decrease in the price of goods and services. The real danger of deflation is falling into a deflationary spiral. A deflationary spiral occurs when consumers expect prices to fall, so they delay spending. Retailers and suppliers need to provide goods and services so they lower prices. If consumers do not spend producers are forced to cut back on costs, including labor, which increases the incentive for consumers to save and not spend. Unemployment can soar and many firms can be forced to shut down. A deflationary spiral is part of the cause of the Great Depression. Unemployment above natural levels harms the economy its participants. People out of the work force longer than frictionally required can start to lose skills, which can limit long term employability. Unemployment also reduces the ability of families to provide necessities and luxuries for themselves. This is all compounded by the general negative psychological effects of unemployment on the unemployed. For the economy it is also harmful. It means productive capacity is idle and the amount of goods and services the economy can produce falls. It is necessary to intervene to protect against the dangers of inflation, deflation, and unemployment. Intervention can be taken too far however. Intervention during the growth side of the business cycle to cool the economy can force it into a deep recession or depression is the intervention is no calibrated correctly. Similarly pro-growth policy enacted during the recessionary period of the business cycle can cause the economy to grow too much causing inflation. Intervention is necessary to protect the economy, but must also be appropriately calibrated to not cause harms on the other side of the business cycle. 2) During a recession governments and policy makers have a wide variety of tools at their disposal. They can be roughly grouped into two categories: monetary policy and fiscal policy. Monetary policy is policy effecting the supply and circulation of money, while fiscal policy relates to funds raised and spent by the government. Monetary policy during a recession is designed to increase the supply and velocity of money. The main actor in monetary policy in the United States is The Federal Reserve Bank (the Fed). The Fed has two main tools at its disposal during a recession: decrease the federal funds rate and decrease the reserve ratio. The federal funds rate is the interest rate at which banks make short term loans to each other. The Fed does this through Treasury bond sales and purchases. By lowering this rate the fed lowers interest rates across the economy. Lower interest rates make it cheaper for firms to finance investment and individuals to finance consumption, both of which help grow the economy. The second tool, lowering the required reserve ratio, increases the amount of money in the system. The reserve ratio is the amount of capital banks must carry on their balance sheet in comparison to the amount of outstanding loans. By lowering the reserve ratio banks can lend more money increasing the amount of money in circulation. Expansionary fiscal policy has two avenues. First increase government spending, and second, lower taxes. By spending money during a recession the government, the government spurs spending on the part of workers who are now receiving payments and firms hired to provide the goods and services for projects. Lowering taxes or providing rebates lets people have or keep more income, hopefully resulting in increased spending. 3) The fiscal and monetary policies available to cool the economy during an expansion are the inverse of those in question two. The Fed can raise interest rates through the purchase and sale of treasury bonds by the Federal Open Market Committee. Raising interest rates makes loans for investment more expensive and thereby slows growth. The Fed can also raise the required reserve ratio, taking money out of circulation. The banks are required to a higher percentage of capital on hand. This causes less to be lent, thereby decreasing the money multiplier. The effect is to remove money from circulation. On the fiscal side government can decrease investment or lower federal expenditures. The more easily applied fiscal policy is to increase taxes, lowering the amount of money people have to spend, thereby cooling the economy. This can also build a reserve of funds to be used when the economy shrinks into recession. 4) Income ought to be redistributed to the extent that the redistribution increases the overall income of the society, while ensuring the basic needs of as many citizens as possible are met. Governments have many tools to redistribute income. These can come in the form of direct payments, such as welfare or food stamps. Redistribution can also come in more subtle forms such as public goods, like roads, schools, and defense. The United States has a graduated income tax policy which taxes those earning more income at higher rates. Those tax revenues are used to provide goods to everyone. Goods like roads and public education increase the ability of the society to be more productive as a whole. Public schools allow for all children to get an education and acquire basic skills, adding to the stock of human capital. Roads allow for the transportation of goods and services increasing the efficiency of exchange. It is important to not redistribute so much that the profit motive is lost. This is necessary to maintain the incentives to produce and innovate. If people are not allowed to keep the fruits of their labor they are far less likely to want to produce, leading to a lower standard of living for all. 5) The Malthusian Trap is the idea that long term population growth will match economic growth. The result is that per capita income can never rise. Population will simply grow to match income. The Malthusian Trap can be escaped by economies increasing wealth and human capital. Once a nation has reached a certain level of wealth population growth rates begin to moderate and can even become negative. In poorer nations where labor is unskilled there is an incentive for families to be large to increase family income. Children are relatively inexpensive and can provide income or labor within a few years. Contrast this with wealthy countries. Children are expensive and require at least a decade and a half of care and education before they can hope of contributing to income. More time and energy are needed for education and to develop the skills necessary to thrive in a wealthy economy. A large investment must be made with little to no return for years. This slows population growth, escaping the Malthusian trap. 6) Human capital is the knowledge and skills that workers have that allows them to be productive. Human capital is usually gathered through education or experience. The range of skills and education can vary widely. For instance the ability to speak more than one language is a form of human capital. This could allow a worker to translate from one language to another or simply apply his or her other skills in more than one nation. This is a skill that could be acquired through education or experience. Another example is simply the ability to read, write and do simple math problems. These skills were so essential that the public education system was set up to make them widely dispersed. Any type of knowledge or skill that a worker has, so long as it can be put to productive use, is human capital. Human capital adds to growth by allowing more output per worker. Also it allows economies to become more advanced by providing more complex, and therefore usually valuable goods and services. 7) The five macroeconomic factors I see threatening the United States are the national debt, financial moral hazard, the dollar’s loss of reserve status, declining education and threats to property rights. The national debt, the amount that the United States owes its bond holders and other creditors, is at record highs. The interest on the debt is projected to increase to crowd out all spending except entitlements. This would cut investment, threaten national defense and infrastructure. The U.S. dollar serves as the reserve currency for the world. This gives the United States an advantage when it issues bonds and needs funding. If other governments and investors lost faith in the US dollar the ability to fund ongoing operation of government as well as the value of the dollar would be at risk. The financial crisis exposed high risk lending by banks and financial firms that were found to be “too big to fail” that the public had to pay for. The banks were not made smaller. There is no incentive for the banks to take less risk now that they know they will be bailed out. This moral hazard could expose the U.S. and world economies to further losses. The U.S. used to be an educational leader in the world. It has begun to fall behind particularly in math and science. These skills are also becoming more necessary as they are critical for innovation and technology development. Failing to develop human capital could lead to lower growth rates. The foreclosure crisis and mortgage crisis threatens the property rights of homeowners in the US. The prevalence of foreclosure fraud risks further undermining confidence in the housing market. Improper foreclosures also create further moral hazard on the part of the banks which did not properly file paperwork but are profiting. 8) The United States is exceptional in the world economy because of the unique protection of property rights. These property rights are core to the markets for real property markets and capitalism as it is applied in the United States. These rights are core because they provide assurance of ownership and thereby profit. Property in the U.S. is protected from being falsely taken by the purchasing process as well as the legal foreclosure process. The purchasing process in the U.S. is extensive in order to ensure that property being sold is owned by the person selling it and that all parties in the transaction are protected. These protections extend to the foreclosure process where essentially a judicially supervised sale is made for the benefit of the lender. This process is also onerous in order to protect the rights of the lender as well as the home owner being foreclosed upon. These strict requirements are necessary in order to assure homeowners that when they buy a home they will actually own it. Also lenders must be protected in order to have assurances that loans made are secured. All parties must be protected in the process to ensure smooth transactions. Extensive protection of property right is essential, which is why the threats posed by foreclosure fraud are so dangerous to the U.S. economy. References Ritholtz, Barry.“Why Foreclosure Fraud is so Dangerous to Our System of Property Rights.” Business Insider. Oct. 12, 2010: Online. Read More