How U.S. Government and regulatory bodies can manage business cycles - Essay Example

How U.S. Government and Regulatory Bodies Can Manage Business Cycles Introduction Business cycles can be defined as larger fluctuations in the economic activities or in the production of goods and services over a long period of time. It is sometimes known as economic cycle and is often associated with periods of high economic growth or high production and those periods of low economic growth. The business cycle therefore consists of periods of economic booms as well as periods of economic recession or decline. The measurement for the business cycle is often done by the government through the measure of the Gross Domestic Product (GDP) of a particular nation. It is however important to note that even though it is termed as a business cycle; it does not follow ant pattern or any mechanically predictable pattern (Lynch, 85). In this context, it is therefore difficult to tell what pattern or direction the future cycle will take. This presents a challenge to the managements of the business cycles and call for better ways of forecasting. The explanation of the causes of the business cycles remains some of the controversial issues in the analysis of economic growth in many economies (Hill, 320). One of the most common known causes of business cycles is the disequilibrium commonly known as the Keynesian theory. This theory is based on the argument that the fluctuation in the economy often begin because of lack of demand for the workers or labor. The argument here is that labor market or demand for labor do not adjust immediately but take very long time and hence it is difficult for the government to adjust appropriately and at the right time (Agnew, 197). The lack of demand for workers often adjust after very long period of time and the result of this is that it takes time. Moreover, the wages for labor and the prices are sticky as some are not easily adjustable and hence it takes very long time for the labor market to respond to the demand. “If output goes down it is due to that market fails to clear pushing the economy into recession” (Brentani, 109). This explains the downwards and the upward trends in the economy that forms the business cycles witnessed not only in the United States of America but also in the other nations across the world. The real business cycle theory on the other hand asserts that the changes or the fluctuations in business occur as a result of real factors. It is important to note that this theory believes that the government should not take part in controlling the market forces. The market forces of demand and supply should be left to adjust on their own (Treve, 72). The intervention of the government through the monetary as well as fiscal policies is not necessary, because the economy is capable of adjusting to the changes on its own. This theory also puts more emphasis on the substitution of labor and technological shocks as the major causes of business cycles. Failure of the economy to adjust to these changes would therefore lead to economy moving to recession. With regard to this theory, the rates of changes or the degree to which workers responds to incentives determines the supply of labor. Fluctuations in the level of technology also have serious impacts on the labor productivity because it affects the incentives (Knoop, 251). The high rise in technology would improve the productivity of labor and hence the real wages would rise as well. This would then result into the increase in the output and rates of employment and vice versa. This theory has also considered other factors like terrorism, disasters, political unrests, weather conditions among other factors that can affect output of an economy. In this way of argument, money does not impact on output neither does output impact on money and hence both move together in the same direction (Knoop, 253). Real business cycle theory is thus very important in the understanding of business cycle theory. However, just like any other theory, it is not perfect and has its own limitations. The impacts of business cycles are important as well before we can embark on the possible management strategies being employed by the United States of America and other regulatory bodies (Montgomery & Glazer, 67). During the times of high productivity, there is high growth in the economy which is characterized with high levels of employments, high productivity, increase in the GDP as well as the development in major economic sectors and industrialization. This implies that the living standards of individuals are improved with better shelter, food, security and improved social life. On the other hand, during economic or business decline, the nation begins to experience the negative impacts on the economy which includes but not limited to the increased rates of unemployment, reduced GDP, reduced investments levels and lack of development in many economic sectors (Treve, 73). In this respect, it is important to understand some of the major ways of managing the business cycles so as to cushion the economy against the impacts which are sometimes devastating. Understanding and the management of business cycles would be very beneficial to the United States and other business partner since it results into stable economy that is capable of attracting even more investors. The government would also benefit from the stabilized economy since the government would be able to forecast accurately and draw plans that are useful for its people in the future (Vaidya, 97). The general impact of business cycle management would therefore be steady growth of economy for the betterments of its people. Literature Review Research has revealed different methods that can be used by the governments such as the government of the United States of America and other regulatory bodies like the World Bank to manage business cycles and fluctuations in the economy. The broadest ways in which the business cycles can be managed traditionally includes the involvement of the government through regulation or by leaving the forces in play to adjust by themselves. According to Black (77), the involvement of the government especially at the top through the management or control of the micro economy and other business cycles is very important. This can be done through stimulus and may be important rather than leaving the forces of demand and supply to adjust the system to the impact of fluctuations. While this is a very fast method and makes the market to react fast to the changes, some scholars have argued that the control of the economic forces cannot be left in the hands of the government. This is because the government is not innovative enough to ensure that the forces take the correct direction. Other critics of the government involvement in correcting the forces in the market argue that the government is not accurate and may over exaggerate the business cycle’s remedy (Black, 159). The argument that the government would not be creative or innovative as the players in the market is very important as it indicates how the market forces alone can adjust itself. This school of thought asserts that the government and its stimulus package may overstretch and cause even more harm than good for its people. According to Drucker (77), if the economy is not stimulated by the government money, it is likely to experience recession. In this perspective, the government may decide to take an active part in controlling major inducers in the economy so as to ensure that the impacts on the economy are cushioned in the short run. However as Mitchell (540), warned, with the fiscal stimulus, the people are likely to enjoy a smooth business line without fluctuations in the short run. However, in the long run, the people are likely to face serious economic problems. Some of the impacts of the government stimulus may include but not limited to inflation, crowding out effects, taxes, non competitive businesses and debts. The other impact would be the loss of creativity and innovation in the market economy and it is not desirable for major economy like that in the United States of America. With the government stimulus package injected in the economic system, there would be continuation of the inefficient companies. These are companies that are not able to survive the hard economic times and hence they are likely to collapse during economic decline (Smith, 197). The businesses that may not survive the business cycles are often assisted by the government because of one or two reasons. For example, the government of the United States of America decides to inject stimulus into the economy to protect certain companies that are producing important goods for the economy. It may also do this to protect the domestic companies from the harsh competitive environments in the international market. While this action is good and is intended to manage the business cycles in the long run, it presents a big problem in the long run because the companies that are inefficient are protected and hence lack innovation and creativity. This is the price that the government would have to pay in the future. Fiscal lag is the time taken by the government’s stimulus to bring the desired effect in the market economy. Economists have argued that the fiscal stimulus lag proceeding to a period of two years or more (Drucker 77). In this regard, the government fiscal stimulus would not be very useful in the management of the business cycle because by this time, the natural market forces shall have made the required adjustments. The impacts or the effects of the fiscal stimulus would therefore be not necessary and may result into other undesirable effects that may lead to inequality again (Cardarelli, 15). Natural adjustments by the forces in economy are therefore recommended for all the business cycles since the people are believed to be more innovative and creative than the government. In a study by Navarro (95), democracy is the best way to solve people’s economic problems since it gives the power to the people to solve their problems on the most precise manner possible. In his study he also asserts that people while enlightened by their own self interests are capable of finding some of the best innovative solutions to their problems. Navarro (97) also argues that this may take very long time before the adjustments are made because the government would be acting as well as the individual people. The result of this is that the central authority would not work with its fiscal stimulus towards the same direction as the people. This is because the government would be acting on the statistics and data on the income, rate of employment and so own while the individual would be acting on self interest (Hiles, 185). The general argument here is that the government is not capable of restoring fluctuations within the market in the long run but can sufficiently manage business cycles in the short run. There are several methods that the government may employ in order to manage the business cycles mainly in the short run as outlined in the discussions above. These are called fiscal methods and hence involve different levels of taxations that are mainly aimed at controlling demand and supply at particular levels. According to Wittkopf (102), tax on the income can be used both to make workers work for more hours or less hours. By increasing the tax rate with the increasing pay, the workers may choose to work for few hours because after all the tax contribution would be less. However, through taxation of the low income earners at low rates, they would be willing to work for extra hours so that they may retain the high income. This is a fiscal policy that may be used to encourage spending by the customers. It may also be used to encourage the workers to pay for more or contribute more to the securities (Wittkopf, 102). Moreover, the government may also use this as a tool to reducing the “poverty gap.” “The encouragements in the working hours would definitely improve incentives and results into the supply of labor and hence there would be reduction in the equilibrium rate of unemployment” (Graf, 85). In the cases of market failure to adjust to the changes through price mechanism ad other forces, the fluctuations may be rectified through indirect taxes. The action by the government on indirect taxes on the goods and services may be useful in the management of people spending. However the types of goods and services have to be picked well so that the general public do not suffer from the increment. For example, the government or the regulatory authority may decide to increase the taxation on luxuries such as alcohol and cigarettes and hence discourage the consumption of such goods. On the other hand, the government may also use the subsidies and other regulatory funds to finance the production of goods and services that are essential for the populations. The result of this is that the prices would go down and the goods and services would be affordable to the people. According to Frumkin (46), taxation have a lot of influence on the business investments and the decision making process. The overall goal of all investors in every economy is to ensure that they make profits at the least cost possible. The ease with which the business and companies can register and begin their operations at the least cost determines the levels of investments (Frumkin, 47). Certain economies have problems with the business regulatory authorities and hence investors often take long time before they can be register and finally begin their operations. These logistical difficulties and challenges discourage investors and hence are not desirable. However the government can play a vital role in influencing investment through taxing and tax systems. Tax allowances may be used to encourage start up businesses. The increase in foreign investments is therefore a stimulus that would be necessary for the development of the economy as well as the increase in the capital stock per worker. Different fiscal and monetary policies are therefore used with regard to the improvements and development of a more stable economy. However, the use of different tax regimes needs high level of care in their implementation since it may result into a positive feedback rather than a negative feedback to correct the economic cycle. Each tax regime chosen depends on the requirements of the government and where the direction needed for the equilibrium to move. These have the impacts on demands and supply which restores equilibrium at the market. The reduced taxes on investments are important as well since they lead to the increase in foreign investments that do not only increase the capital investments but also affects the amounts that are reserved per employer in the nation. Effectiveness of Monetary or Fiscal policy Research has shown that fiscal policy is very effective when the economy is on recession and hence there is need for an urgent action. Fiscal policy is particularly more effective in stimulating demand and would be desirable during recession. However as stated by Raju (120), other economists have disagreed with this statements arguing that monetary policy ahs the quickest impact on the economy during the time of recession. However, as observed by Raju (120), there are several factors that make fiscal policy ineffective apart from the usual crowding phenomena. For example, people often anticipate the impacts of the government behaviors and hence react before the impacts falls on them. Another example, increase in government spending may result into increased savings because of the expectations of the rise in prices and the living standards in general. The increase in savings would therefore be an anticipation of this action by the government. The difference in the fiscal policy and monetary policy is therefore based on the time lag (Sihler, & Crawford, 175). In the United States of America, monetary policy is flexible and hence would result into quick reduction or increase in interest rates that would be important in influencing the direction of investments and hence capital. Monetary policy is therefore the best policy for the government of the United States of America to adopt. Conclusions Business cycle is vital aspects of economic development since it influences the growth and development of economy. Economic recessions are therefore dangerous aspects of business cycle since it results into increased standards of living as well as discouraging investors and foreign business. The government should therefore take an important step towards the management of business cycles that threatens the economy. The monetary policy unlike the fiscal policy is one of the best management tools that this paper proposes for United States of America. This is because monetary policy is flexible and good for planning since investments are important for the long term business cycle management. Unlike fiscal policy that is affected by the overcrowding phenomena and the behaviors of the anticipating consumers, monetary policy is effective in increasing productivity which is vital in restoring equilibrium. However, mixed market economy is still vital for the government of U.S. and the absolute control of the market forces would not be desirable. This is because it kills creativity and innovation and makes company inefficient in their operations. Works Cited Agnew John A. “Globalization and sovereignty.” United States of America: Rowman & Littlefield publishers, 2009. Black, Fischer. “Business Cycles and Equilibrium.” New jersey: John Wiley and Sons, 2010. 77-159. Brentani, Christine. “Portfolio management in practice.” Oxford: Elsevier Butterworth-Heinemann, 2001. Cardarelli, Roberto. “Economic integration, business cycle, and productivity in North America.” Washington, DSC: International Monetary Fund, 2004. Drucker, Peter F. “The practice of management.” Oxford: Elsevier, 2007. Frumkin, Norman. “Tracking America's economy.” New York: ME Sharpe inc., 2004. 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