Financial Crises into the United States - Research Paper Example

? Budget /Financial crises Contents Introduction 3 Research aims and objectives 4 Research Question 4 Literature Review 4 Research Limitations 7 Research findings and Analysis 7 Recommendations 10 Works Cite 12 Introduction The financial collapse that took place in 1929 indicated the U.S. government and the people that a deregulated financial system can lead to financial crisis. The economic and political viability of the country was under threat in the case of 1930s. The decade in the 1930 to 1940s witnessed the most stringent financial system than ever before. The financial sector was regarded as the servant of the real sector. The financial sector was thought to contribute in the most efficient fashion in economic performance for the years to come. The U.S. economy is regarded as the world’s largest economy and it possesses the characteristics of a mixed economy. The budget deficit for the financial year 2012 is 1,327 billion dollars (Chantril). The deficit for the year 2011 and 2010 was 1, 300 billion dollars and 1,293 billion dollars respectively (Chantril). Free market system exists in the economy. There is correlation between the federal budget and economy. The budget impacts on the growth of the economy and allocation or redistribution of resources. The difference between budgetary spending and revenues is defined as the budget deficit. Budget deficit contribute in the level of national debt. A variety of problems can result because of budget deficit. Lower national savings rate, higher rates of interest and inflation are some of them. The federal budget is taking an unsustainable path. The debt levels of the federal are expected to grow with the size of the economy. The elevated budget deficit is the cause of increase in federal debt. This will shed its effects on economic downturn. The excess expenditure is financed through borrowing. The federal government takes the policy of issuing securities. The households can make up their budget deficits through loans and credit cards. Some of the measures to curb down the budget deficit are cutting expenditures, levee taxes or a strategy that will involve both. Research aims and objectives The aim of the research is to identify the causes of the debt and how to overcome the crisis and how to overcome the crisis. Research Question Can the debt be corrected without raising taxes? Literature Review The rapid appreciation of the dollar was one of the important topics in the early 1980s. The U.S. deficit is hold to be one of the reasons for the appreciation. The real interest rates will get affected by any increase in the amount of deficit. The high interest rate will crowd out private investment spending. Such crowded out funds will find its destinations in other parts of the world. As the capital account surplus rises in the U.S., the real exchange value of the dollar will take the steep path upwards. Economists have not been able to land upon on a unanimous decision on the cause behind the changes in the value of dollar. The market’s expectation on the future behavior should be reflected in the current exchange rate. The observed and expected current fiscal policy of the country is assumed to have significant effects on the international exchange rates because of globalization. The rapid increase in expectation on future deficits has contributed in changes in the dollar value in the initial years of 1980s. Again the reduction in the value of dollar in 1985 may be due to the fall in expected deficit in the budget (Melvin, Sclagenhauf and Talu, 2012, 500). Now we consider the present situation of the national debt. The debt amount currently exceeds 10 trillion dollars. Economists are of the opinion that the level of the debt is not alarming when compared in international standards. The current account in the balance of payments statistics is the prime reason for the deficit. The record displays the flow of transactions over a period of time. The accumulated wealth owned by the federal government is regarded as the national debt. Another factor that correlates with national debt is federal debt. The country has created a deficit that has increased the debt of the nation throughout the last decade. Spending more money than earned is the cause of the deficit. Some of the causes that resulted in this huge burden of deficit are excessive spending on defense services during periods of war. The country has also launched itself in borrowing money from other nations. The country lacked the ability to pay back the borrowings. Recessions also seems to have its effects on the amount of deficit (O’ Sullivan, Arthur and Steven). The increasing debt aroused from the failure of the government to manage the financial issues. The federal spending has exceeded federal revenues over the last decade. The government is involved in policies that require more money to spend than earned. The main cause of the deficit is excessive spending by the department of treasury. Borrowed money can be a way of reducing deficits but can lead to national debt. The war in the Middle East can also be thought of increase in debt and increase in spending. The war resulted from the attacks on September 11, 2001. The war called for more money in defense services. The war involves some expensive spending on transportation of troops and manufacturing modernized weapons (National Priorities Project). This was a very important factor in the increase in deficits in the early part of 2000s as it prevented the country from paying back the bonds. The economy experienced a surplus in 2001 for the last time. Since 2001 the government has failed to end the spending in deficit. The country’s share in total military spending was 37% in 2000. The percentage rose to 44% in 2009 (Democratic Leadership Council). The funds of the government will still be used on military with the continuation of the war instead of using it in the national debt (British Broadcasting Corporation). During the periods of economic turbulence government spending is encouraged and federal revenues are expected to fall. When the country is already facing the tough times of recession increasing the national spending is not beneficial. The problem is more acute when recession shows no sign to end. The amount of money spent is driven the extent of recession (Associated Press). The measure that takes into account all of the federal governments outstanding debt is known gross debt. It is measured by the bills that are outstanding, notes, bonds and other debt instruments. The balances in the federal government’s accounts are represented as debt held by the government. The current federal demand on credit markets is reflected in debt held by the public. The interest paid on the debt acts as the burden on the tax payers. Borrowings by the federal from the public absorb the available resources for private investment and put further pressures on the interest rates. The debt burden is represented as the borrowings of the federal government and is reported as the liability in the balance sheet. But debt held by the government accounts and the interests on it claim on future resources. Federal securities of some special type are credited to the governments accounts represent the cumulative surpluses of these accounts that have been lent to the general fund. These transactions net out on the government’s consolidated financial statements. The debt issued to governments accounts have no impact on the economy and has no motive to compete with the private sector for funds in the credit market. But debt held by government accounts can shed its effects on the future taxpayers by increasing their burden. Gross federal debt is taken to be the measure that is subjected to the limit with some minor adjustments. Gross federal debt is the broadest measure of debt. But all gross debt cannot actually reflect the past borrowing in the market of credit. One of the debts which do so is the unemployment insurance, the highway trust funds and the employee pensions of the federal. The selected federal agencies also hold small amount of debt. The cumulative amount that the government had not to borrow is represented in the trust fund balances. These amounts are simply credited to the accounts of the trust funds. The debt held by the public is the relevant debt measure. This shows the amount of the debt that is actually sold in the markets of credit. These debts affect the rate of interest and decisions of the private investors. The amount measured by dollar is not the appropriate way to judge the burden of the economy. The value of the amount of debt is irrelevant to analyze the burden of the economy. The importance of the debt can only be measured when compared with the overall size of the economy as an individual can decide to take on more debt. The tax base and the burden of the economy is negatively related. The larger the base of the tax will be, the less will be the burden on the economy. This holds true only for a given amount of debt. The most appropriate way of calculating the size of the debt is to express it as the percentage of gross domestic product (United States Government and Accountability Office). Research Limitations The research identifies the causes of the deficit but fails to identify the prime cause of the deficit. The research also identifies the methods by which the amount of the deficit can be reduced but fails to identify the way that will have no impact on the economy. Research findings and Analysis To analyze the real effects on budget deficits, an overlapping generation model for a small economy can be used. The first thing that is required is distinction between traded and non traded goods sectors. The world’s capital market determines the interest rate and the economy has the ability to borrow. The consumption opportunities for domestic residents are affected by government budget deficits. The government balances the budget over a long horizon than any domestic generation. The non traded goods market acts as the link between the generations (Devereux, S206). The prospects for the future and economic progress are the arguments for reducing the deficits. Economists are of the idea that sustaining large deficits can curtail savings and slows down the economic progress. To attain future gains in the standard of living one needs to curtail consumption levels and take steps to increase the level of saving. The federal budget deficit and low rate of savings causes a gap between total savings and investment in the United States. Spreading the foreign ownership of assets and mounting payments of investment will result in capital inflows (Wallich, 78). But trade deficits will also take place because of this reason. As long as capital inflows continue the trade deficits will go on mounting. If investors move away from providing capital under the prevailing circumstances then the interest rates will take the steep rising path. The value of the dollar will fall. This would result to make the U.S. assets cheaper compared to the foreign assets. The capital costs will rise because of high interest rates and will tend to curtail investment. The exchange rates will tend to get low and the price of the imports will rise. This will have negative effects on the standards of living. A large export will be needed for relatively small amount of import. The country will tend to depend more and more on foreign capital (Sanchez, 523). There will not be sufficient investment for technological advancements to take place and expansion of the economy would be a topic of history. The incomes of the workers will be affected and if the situation sustains other nations will drive out the country on the basis of standard of living. The large persistent deficits will create the impossible situation for the future generations to match the financing of the expected government services. Rising of the taxes will be the next alternative and it is unwanted from the point of view of the residents. The goal to increase productivity means that the budget deficit should be reduced in ways that will be ineffective in all forms of investment but will reduce consumption. The policy changes were the combination of legislation for deficit reducing and deficit increasing. The recent steps to curb down deficits were directed on reducing the discretionary spending. By discretionary spending it is meant spending that is provided and controlled through the process of appropriations. The amount of deficit to be reduced depends on the goals of the policy. A low national savings rate is the characteristic of the United States and a policy can be implemented in which the government does not have to follow the policy that will reduce national saving rate (Gramlich, 28). The government could target the budget surplus if the goal of the policy is to increase the rate of national savings or reduce the debt of the federal. Some economists are of the opinion of balanced structural budget. The balanced structural balance will allow for small amounts of deficits in the downturns and surpluses in the budget in the boom periods. One of the policies that may reduce the level of deficits is by printing more money. But printing money can cause high inflation, called hyperinflation (Smith, 717). The country can depend on alternative sources of income. This new sources will decrease the level of debt in the long run. Borrowing money by issuing bonds from consumers and businesses can evolve as alternative sources. But such kind of alternatives can increase national debt. Borrowed money needs to be paid back. A couple of years ago American consumers casted a shadow on the global markets but when the financial crisis started in 2007 a panic sparked in the subprime world particularly on the wave of mortgage defaults. The financial debt of the country has dropped from 8,000 billion dollars to 6,110 billion dollars (Chantril). It now stands at 40% of Gross domestic product. The situation is same as in 2000. The debt on household has declined 584 billion dollars. This is a reduction of 15 points compared to disposable income. The defaults on home loans and consumer debt can be thought of to be the reason. The foreclosure process includes almost 254 billion dollars of mortgages. A total of nine strategies can be identified that can be implemented to address the shortfall in budget. These are both- short term and long term policies. The policies can be broadly categorized into three categories. The first one is application of skill and scale economies. This will reduce the back office costs. The second one is improvement in program efficiencies both within and across agencies. The third one is optimization of government revenue. On the first category, the policies are strategic sourcing, shared services, rationalization and consolidation of IT, managed application services, travel management and facilities optimization. The policies of the second category include rapid process management and citizen services portal. The policies on the third category are audit, compliance and discovery. Strategic sources help to increase the efficiency in management, centralize the procurement process to achieve scale economies, take the advantage of the shift in conditions of the market. Realize combined power of buying, reduce the time in transactions, and establish sets to contest the needs of the businesses; rent rather than purchase and alter physical capital into financial capital. The organizations of the government can decrease the number of complex and risky procurements, bargain healthier prices with vendors, shorten the cycle of procurement, improve the customer service, and increase savings from punctual pay discounts. With rationalization of IT, agencies will have the potential to drive down the headcounts for application maintenance. This will lower the costs of application and hardware. This will also provide the opportunity for better utilization of server and service levels will improve. Recommendations The future levels in the debt of the federal is a concerning issue for the budget analysts. They agree upon the fact that current spending and collection of revenue cannot continue at the present pace or at the forecasted pace. Several reports have been published showing the ways to achieve the sustainable fiscal path. But all reports include a tradeoff on reduction of favored programs and increasing the tax base. The modifications in the tax laws and cuts on spending can increase the probability to cope up with the situation of financial crisis. This ensured higher standards of living for the generations to come. The reforms are going to be more costly as time passes by without any planned fiscal future. A situation will arise when the reforms will be forced which will again result in financial crisis. So the reforms need to be well planned. The fiscal reform plans propose to implement the recommendations at the beginning of the financial year, 2012. The goal is to stabilize the debt at 60% of Gross domestic Product at the end of the year. They propose to address some of the major issues in the federal healthcare programs and reform of the tax code. Cuts to discretionary programs are also one of their recommendations. Some of the reports even cited on accountability issues. They laid stress on transparency in the budget process and new policies that will pave the way for new budget procedures. Some of the policies include implementation of short term stimulus. This type of stimulus will increase the deficit in the short run before deficit reduction. But the process of deficit reduction will take place once the economy recovers from recession. The fiscal stimulus would reduce the income in the long run. Ultimately little rests on the policy that is being implemented. The key to restoring fiscal sustainability rests on the stabilization of debt. The report of the fiscal commission included cutting of the discretionary spending back to the levels of 2008 by 2013 in real terms. The report provided limitation on the spending at half of the rate of inflation through 2020. Certain discretionary caps can be implemented which will limit the spending in percentage terms, in both types of discretionary spending, security and non security. Managed application services will improve flexibility to adapt to an uncertain future. Works Cite Chantrill, C., “US Government Spending”. usgovernmentspending.com. 2012. Web. 6th April,2012. Melvin, M., Schlagenhauf, D. and Talu, A. “The U.S. budget Deficit and the Foreign Exchange Value of the Dollar”. Jstor.com. 2012. Web. 31st March, 2012. Associated Press. "Recession, Bailout Costs Push Deficit to Record." msnbc.msn.com. Associated Press, 2009. Web. 2nd April, 2012. http://www.msnbc.msn.com/id/29144295. British Broadcasting Corporation. "Foreign Demand for US Debt Drops by Record Amount." news.bbc.co.uk. British Broadcasting Corporation, 2010. Web. 2nd April, 2012. http://news.bbc.co.uk/2/hi/business/8518438.stm. National Priorities Project. "Federal Deficit, Surplus, National Debt." nationalpriorities.org. National Priorities Project, Inc., n.d. Web. 2nd April, 2012. http://nationalpriorities.org/resources/federal-budget-101/budget-briefs/federal-deficit-surplus-and-national-debt. O’Sullivan, Arthur and Steven M. Economics: Principles in Action. Boston: Prentice Hall, 2006. Web. 2nd April, 2012. http://www.time.com/time/nation/article/0,8599,1918390,00.html. Democratic Leadership Council. "American military spending is 43 percent of the world total." dlc.org. Democratic Leadership Council, n.d. Web. 2nd April, 2012 http://www.dlc.org/ndol_ci.cfm?kaid=108&subid=900003&contentid=255176. United States Government and Accountability Office. “Federal Debt : Answers to frequently asked questions, An update.”. 1999. gao.gov. Web. 2nd April, 2012. Wallich, H.“Income Generating Effects of A Balanced budget”. Jstor.com. Oxford University Press. 2012. Web. 2nd April, 2012. Gramlich, E. “Budget Deficit and National Saving: Are Politicians Exogenous?.” 1989. American Economic Association. Jstor.com. Web. 2nd April, 2012. Devereux, M. “Anticipated budget deficits and real exchange rate”. 1995. University of British Columbia. Jstor.com. Web. 2nd April, 2012. Smith, B. “Government expenditure, deficits and inflation: on the impossibility of balanced budget.” Jstor.com. 1985. Oxford University Press. Web. 2nd April, 2012. Sanchez, M. “Financial crisis: prevention, correction and monetary policy.” Cato institute. Web. 2nd April, 2012. Read More