Fiscal and Monetary Policy
Posted by Melda Research on April 24th, 2019
1. Discuss the current economic situation in the U.S. as compared to five years ago. Include inflation, interest rates, and the unemployment rate in your explanation.
The status of the U.S economy is better today than five years ago going by key indicators such as interest rates, the inflation rate, and the rate of unemployment. In 2014, interest rates were significant lower than five years ago averaging at 1.68% as compared to 2.50%, in 2010 (Barcharts, 2014). Low-interest rate is an indication that the economy is in good health as it facilitates consumption and investment. Unemployment rates have also declined over the past five years from 9.5% in 2010 to 5.8% in 2014 (U.S. Census Bureau, 2014). Declining unemployment rate also connotes an improvement in the economic position of the country. However, the inflation rate in 2014 has increased marginally from the 2010 figure standing at 1.7% as compared to 1.6%, in 2010.
The change in interest rate may attribute to government actions through the Federal Reserve. Five years ago, the government initiated extraordinary actions in reaction to the global economic crisis so as to stabilize the economy (Cukierman, 2013). One of these actions entailed reducing the interest rate for government securities to near zero. This action discouraged private from lending to the government; hence, release additional cash to the economy. The additional cash led to lower cost of obtaining loans.
The decline in the unemployment rate attributes to the recovery of the economy. Several actions led to a decline in the rate of unemployment. First, the decline in interest rate made money available to the private sector thus stimulating investment and consumption activities (Labonte, 2014). These activities, in turn, generated employment for citizens leading to a decline in unemployment rates. Another factor that has led to reduced unemployment rate in increased government participation in the economy through the Federal Reserve. Since 2009, the government has been an active participant in the economy, buying and selling security through the Federal Reserve. This action has helped stabilize the economy by controlling the liquidity and the inflation status of the economy.
The marginal increase in inflation rate attributes to the low-interest rates in the country. Low-interest rate has increased consumption by making cash readily available to citizens (Cukierman, 2013). Availability of additional cash in the economy has, in turn, increased demand for commodities leading to hiking of the prices of these commodities.
A significant monetary strategy that would encourage people to spend money is reducing the interest rate on government security (Branch, Davig & McGouch, 2008). Reducing the interest rate on government security will reduce the sum of money that the government takes from the economy thus making money readily available to private individuals at lower rates. Reduction in interest rates that financial interest charge members of the public will spur consumptions hence creates economic growth. Low-interest rate will also make money readily available to producers, who would invest in improving their level of production so as to meet increased demand.
A significant fiscal policy that would encourage people to spend money is reducing the taxation rates. Reducing the taxation rates will increase the amount of disposable income among private individuals; hence, it will empower private citizens to increase their expenditures (Branch, Davig & McGouch, 2008). Producers will respond to the increased expenditure by increasing their level of production; thus, create economic growth. Lowering the rates of taxation will also provide an incentive for businesses to increase their production level so as to meet the growth in demand.
Reducing the interest rate on government security will reduce interest and unemployment rates. The reduction in government borrowing rates will encourage lending institutions to lend to the public; hence, lower the interest rates. Lower interest rate will, in turn, increase consumption and investment activities by private entities; thus, it will create economic growth (Labonte, 2014). Economic growth will create additional employment opportunities; hence, it will lead a reduction in the unemployment rate. A reduction in government borrowing rate will lead to an rise in the level of inflation as it will increase the amount of money circulating in the economy.
Reducing the rate of taxation will also reduce the rate of unemployment. A reduction in the taxation rates will increase consumption and investment activities by increasing the citizen’s disposable income. The increase in investment and consumption activities will, in turn, generate additional employment opportunities leading to a reduction in the unemployment rates (Cukierman, 2013). Reducing tax rates will also increase inflation rates by increasing the amount of money circulating within the economy. A reduction in the taxation rate will not have an effect on interest rates.
Imperfectly competitive monopolistic firms maximize profits equating marginal costs and marginal revenues. Firms make supernormal normal profits, in the short run, but the profit is eroded as new firms join the market (Cukierman, 2013). Imperfectly competitive monopolistic firm try to remain in the short-run position by innovating and differentiating their products further. Government use monetary policy to manage the economy by manipulating interest rates; hence, influencing the level of consumption and inflation. The government uses fiscal policies such as tax reduction to manipulate expenditure and inflation rates.
The status of the U.S. economy has improved over the past five years going by key indicators such as unemployment and interest rates. Changes in these indicators attribute to the government fiscal and monetary policies. After the 2008 economic turmoil, the government initiated monetary and fiscal policies that targeted to increase expenditure and stimulate economic growth. These policies entailed reducing interest rates on government security, lowering taxation rates and increasing government expenditure.
Barcharts.com (2014). Five-year interest rates.
Branch, W. Davig, T. & McGouch, B., (2008). Monetary-Fiscal Policy Interactions. Journal of Money, Banking, and Credit. 40 (5), 1096- 1102
Cukierman, A., (2013). Monetary policy and institutions after the financial crisis. Financial Stability. 30 (1), 349- 361
Labonte, M., (2014). Monetary policy and the Federal Reserve.
U.S. Census Bureau (2014). America’s Economy.
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