The United States Business Economics - Essay Example

?Business Economics US economy is still under the curse of the financial crisis that led to bankruptcy and widespread unemployment. The crisis refuses to die down as USA is unable to repay its debt. The economy is already caught in the debt trap. Rating agencies have assigned low ratings to the US economy owing to the crisis. Standard has already have taken back the ‘AAA’ status that it had once given to the US economy. Predictions of OECD OECD has predicted more trouble for the US economy in the near future. The organization has forecasted shrinkage of the world economy owing to the recent financial crisis that led many US companies to bankruptcy. Euro crisis is supposed to result in negative growth for the next upcoming six months. Apart from US, the British are encountering the problem of double dip recession (Winnett, 2011). Currently OECD is giving warning to the US government about an emerging economic slowdown that the country might have to encounter soon. OECD claims to derive such a result from the composite index of the leading indicators. Such alerts have been issued for the seven major economies. It is mostly using CLI instrument to get early signals of downturn from the upswings and downswings within the periodical growth cycle. Such an instrument will surely help OECD to send out early alerts to the economies (Major economies globally heading towards slowdown: OECD, 2008). Symptoms for such a slowdown will be continuous fluctuations in business cycles. Such fluctuations will linger for a long period of time. Slowdown in the euro zone will lose out the confidence of investors especially in the financial markets. This could be the main reason behind output contraction in the major economies. United States is already experiencing cyclical slowdowns. Such a trouble had not touched US economy in the last 10 years (Major economies globally heading towards slowdown: OECD, 2008). Preannounced liquidity shocks have been hitting the US economy. Due to such shocks US economy is undergoing unexpectedly large price changes. In recent times jumps in US treasury bonds have been identified (Jiang and George, 2011). Earlier in 1999, OECD had predicted much slower growth in the overall industrialization process for the United States. Accordingly there has a decrease in the short term rate of Federal Reserve Board (Wessel, 98). As per OECD, such a slow and weak growth for the United States is likely to continue till 2013. This will continue along with high unemployment (Winning and Parussini, 2011). The current economic crisis and the Federal government: There are two schools of thought on how the USA government should deal with its current economic problems. One thought deals with the policy of significant deficit reduction that the Greek and Irish governments have implemented. And the other one deals with the substantive Keynesian stimulus package. The later aspect includes a reform of the tax system in order to make taxation more progressive (Kitromilides, n.d.). Policies of deficit reduction: Policies: During the financial crisis and huge debt crisis situation, governments of Greece and Ireland have taken some policies to surmount those crises. In the face of the huge accumulation of budget deficit, debt crisis, in 2010, the both the governments have taken policies to reduce these crises. At first both the governments have taken steps to reduce public expenditures and increase tax rates. This was a policy of fiscal consolidation plan. Along with this both the governments have asked for the financial assistance to IMF and EU. At the same time these governments have taken steps to initiate long-term structural reforms, such as, increasing competitiveness of the economies by improving employment and growth scenarios, enhancing private sector investments, and most importantly boosting the R&D sector of the economies (Kitromilides, n.d.). Explanations on effectiveness: These policies are still under the scrutiny, but they have been successful in the short term. The policy of reducing public expenditure basically helps the economy to reduce the deficit directly by reducing its overall expenditure on goods and services. This helps to take lesser volume of loans from other countries or international organizations. Again the policy of increasing the tax rates has two effects on the economy. The first effect deals with the fact that it forces citizens to reduce their expenditures on the luxury goods (by reducing the volume of money supply in the economy) and the same time it increases the total revenue of the government which it can use to finance the ongoing debt. By increasing employment opportunities, taking steps to boost up the economy’s growth rates and investing largely on R&D help the economy to increase the pace of economic expansion at the same time it helps to reduce deficits by increasing the aggregate demand for domestically produced goods and services. The effects are shown below graphically using the AS-AD schedules (Kitromilides, n.d.): 0 US government can use these policies to reduce its ongoing budget deficit. These policies have been quite successful in case of Greece and Ireland. These policies are most likely to reduce the deficit in the medium and long term by reducing the volume of money supply in the economy. US economy, the largest open economy in the world, is likely to be very positively affected by these policies. The downgrade in the credit rating implied that there is a lack of both economic and political stability in the US. Hence, it becomes absolutely necessary to implement these policies to avoid this crisis situation (Kitromilides, n.d.). Keynesian prescription of deficit reduction: The Keynesian prescription basically deals with the fiscal policies related to the operation of the government. These include changes in the government expenditure, reform in taxation systems etc. In the presence of the public deficit the government does not have enough money or other liquid resource which help it to reduce the deficit. Following the Keynesian stimulus package it becomes necessary for the government to increase the tax rate that will generate more revenues to the government and hence it can be used to reduce the volume of deficit. The tax rate has a positive effect and a negative effect. The effect of higher revenue generation is the positive effect. On the contrary, a higher tax rate means lower disposable income to the people and it forces them to reduce their demand for goods and services. Hence, the aggregate demand in the economy falls and that reduces the income level and increases the inflation rate. All these ultimately deepen the problem of crisis. Hence, the ultimate effect depends upon the relative strengths of these two effects. But it can be theoretically proven that in the face of huge deficit the positive effect becomes the dominant effect and it helps to overcome the deficit situation. Credit crunch and USA & UK: The credit crunch or the credit crisis is the starting point of the crisis that is happening at present in the USA and in the UK. It started in the 2007 and caused many of the banks and financial corporations in USA, like Lehman Brothers, Merrill Lynch, to collapse. The situation started with the huge disbursements of loans by several American financial institutions. The situation started with the default in the mortgaged loans in a very small part of the US financial markets. Then it evolved as the greater problem in 2008 with the collapse of the most of the financially strong banks in the country, when the hedge funds had no money to lend (Mizen, 2008, p. 533). The problem of credit crunch of 2007 affected largely the economies of USA and UK because these are world’s largest market–dependent economies. Financial sectors of both the countries were lacking funds and resources to operate in the markets. Interest rates on loans were so high that it became very difficult for the investors to invest in long term and large investment projects. Hence, the lack of investment ultimately resulted in the reduction in income and expenditure. The level of unemployment reached its peak level of 14% in USA and 17% in UK (Italy and Greece Act With More Force on the Debt Crisis, 2011). And hence a vicious circle of lower income and lower output and deeper crisis has evolved. The problem becomes a deeper one in 2008 when the initial credit crisis eventually becomes the problem of recession in these two countries. It caused the real economic variables (output and expenditure) in both the countries to become more unstable. The situation then affected the other countries’ economies as well (Mizen, 2008, pp. 545-550). Conclusion: The crisis situations in the USA and the UK or in other countries are basically the results of more openness and large dependency upon the market forces. The European nations and USA are free market economies with very little or o government intervention in any sector of the economy. According to Keynes, the most important requirement for an economy to avoid the financial crises situations is rapid and significant and regular government intervention. These governments are finally taking the fiscal policies to stabilize the markets and improving the health of their economies. References 1. Major Economies globally heading towards Slowdown (2008), The Economic Times, Available at: http://articles.economictimes.indiatimes.com/2008-11-07/news/27733830_1_oecd-cli-economies (accessed on November 28, 2011) 2. George, J and Jiang , (2011), Information Shocks, Liquidity Shocks, Jumps, and Price Discovery: Evidence from the U.S. Treasury Market, Journal of Financial and Quantitative Analysis, Vol.4, no. 2, 527-551 3. Wessel, D , (1998), OECD Projects Much Slower `99 Growth For Industrial Nations, Especially U.S., Wall Street Journal, Vol. 232, No.99, A4 4. Winnett, R, (2011). OECD figures suggest Britain's economy will slip back into recession at the start of next year. Available at: http://www.telegraph.co.uk/news/politics/8917161/OECD-figures-suggest-Britains-economy-will-slip-back-into-recession-at-the-start-of-next-year.html (accessed on November 28, 2011) 5. Winning, N and Parussini, G, (2011), OECD Cuts Forecasts For U.S., Euro Zone, The Wall Street Journal. Advance online Publication. Available at: http://online.wsj.com/article/SB10001424052970204528204577009352092988724.html (accessed on November 28, 2011) 6. Mizen, P., (2008), The Credit Crunch of 2007-2008: A Discussion of the Background, Market Reactions, and Policy Responses, Federal Reserve Bank of St. Louis Review, Vol. 90, No.5, pp.531-569 7. Kitromilides, Y. (n.d.), Deficit Reduction Policies, Market, Credibility, and Market Failure, University of Westminster, available at http://www.mdx.ac.uk/Assets/kitromilides.pdf (accessed on November 28, 2011) 8. Italy and Greece Act With More Force on the Debt Crisis, (2011), New York Times, available at: http://www.nytimes.com/2011/11/12/world/europe/under-us-pressure-europeans-seek-response-to-euro-crisis.html?_r=1&scp=5&sq=debt%20crisis%20in%20europe&st=cse (accessed on November 28, 2011) . Read More