Economic policy and global environment - Essay Example

?Economic Policy and Global Environment Introduction Fiscal policy measures are the methods which are applied by the government to adjust the levels of government spending and tax rates that directly influence the growth of an economy. The fiscal policy is used in combination with the monetary policy to control the economic growth (Horton and El-Ganainy, 2012). The monetary and fiscal policies can directly affect the rate of inflation and determine whether the country will face conditions of growth or recession (Kopits and Symansky, 1998). There are various types of rules which must be considered while following the fiscal policy like, Balance Budget Deficit Rules, Borrowing Rules and Debt or Reserve rules. One of the major rules of the fiscal policy is that it is intended to be applied by the successive governments on a consolidated basis, subject to the various statutory instruments. US have been using the statutory instrument of Constitutional amendment on a broad level and these are implemented by the sub-national governments. This paper aims to analyze the fiscal policy measures undertaken in the United States in the current fiscal year and the implications of the same on the daily lives of the people. Summary of the article In the aftermath of the global financial crisis, the growth of the US economy has been adversely affected. The fiscal policy taken by the government in the recent years has been unable to boost the levels of economic growth to the levels prior to that of the crisis. It is believed that the fiscal policy that has been adopted in the current fiscal year of 2013 is likely to dampen the pace of the economic growth. The scuffle over the correct form of fiscal policy in the latest budget has made economists lose faith in the prediction that the fiscal policy in the third quarter would result in buoyant economic growth. These have led to the expectations that the Federal government will not slacken its pace of monetary stimulus, until the second quarter of the next fiscal year, thereby leading to the deduction of 0.3% of the annualized growth rate of GDP in the last quarter of 2013 (Mutikani, 2013). The implications of this on the real economy would be weaker job growth. There have been high job cuts during the financial crisis and the fiscal policies were expected to increase job growths in the subsequent years. The reduction in the government spending in 2012 has resulted in falling growth rates over the last three quarters. The shutdown of the government has greatly impacted the government spending. Though these workers will be paid their salaries retroactively, their better halves in the private sector cannot expect the same and this will lower consumption spending in the festive season. The uncertainty in the political environment is likely to affect the investments in the country, which will further result in the weaker growth. Governments Fiscal Policy: Past and Present perspective Historically, the fiscal policies, adopted by the government at state, local or federal levels, have mostly been tailwind for the economy. This implies that it has tried to boost the economy (International Monetary Fund, 2013). This has drawn references from the history that whenever the economy is in recession, the government follows an expansionary fiscal policy. This can be explained with the help of the following graph. Figure 1: Expansionary Monetary Policy (Source: Burnt Hills-Ballstan Lake, n.d.) If the government follows an expansionary policy, either by raising the level of government spending or reducing the level of the taxes, there is an outward expansion of the aggregate demand curve. This is represented by the shift of the curve from AD0 to AD1 (Burnt Hills-Ballstan Lake, n.d.). In this range of the SRAS, there is almost no effect on the rate of inflation which is measured by the price level, measured in the y-axis of the graph. The rationale working here is that during sluggish economic performance, the revenue that can be earned from taxes falls and the level of government spending has to be raised to provide a stimulus to the economy. The exact opposite happens during the expansion. During recessionary times, automatic-stabilizers are stimulated which works on the above concept in counter-cyclical manner and the economy is expected to stabilize in the long-run (Lucking and Wilson, 2012). Historically, the Federal Reserve has followed unusually expansionary policies during recession. However, during the recent crisis, there have been marked changes in the policy followed by the FED. In the early part of the crisis period, the recovery measure by the FED was based on expansionary fiscal policy. Since 2010, this trend has reversed itself. The FED has been following a contractionary fiscal policy. Though spending has fallen sharply since 2011, there has been an increase in the revenues earned from the taxes. The impact of the fiscal policy depends on the change as a share of GDP and effect of the multiplier on the change in the GDP. If the strength of the multiplier is more, the impact will be more. So, on an average, the fiscal policy is more contractionary than the historical records. This is acting as the major impediment to the growth of real GDP. The fall in the fiscal deficit is the key factor which lowers the growth rate. Challenges Faced by the Government In designing the fiscal policies, the government has faced formidable challenges and hence, decided to reduce the level of spending. The rising age of the population, along with the rising costs of health care, makes expansionary fiscal policies non-feasible in the long run. The rising expenditure by the government would have soon surpassed the revenue earned by government and this could have led to huge deficits (Prante, 2013). Therefore, putting the federal budget on a sustainable part required austere measures in terms of cutting the expenditure by the government. These tasks were even more aggravated by the persistent severity of the economic conditions like, large number of unemployed workers, ailing real estate market and slowing industrial growth. To reduce the spending, three main challenges are faced by the policy makers namely, the degree of reduction to be made in the deficit, the fastness of the reduction process and the correct form of deficit reduction (Elmendorf, 2011). For the first problem, there is no standard or optimal answer. Few factors are considered by the law makers to solve the crisis. They involve measures to relieve long-term pressure on the budget, reducing the risks of financial crisis and improving the flexibility of the government to act flexibly in order to react to the unanticipated changes in the economy. This calls for a higher deficit reduction. The time of deficit reduction is the most crucial problem faced by the policy makers as a slower reduction in the spending and tax hikes would lead to higher accumulation of debts and an abrupt reduction in the reduction in the budget will severely affect the demography as it gives very less planning time to local governments and businesses. The US government believes that sensible steps to reduce the budget deficit can contribute positively to the employment and output in the long-run as the interest rates are held low. The key factor behind the success of the fiscal policy would be the balancing of the reduction in spending and tax hikes and their time frames in affecting the economic growth. As far as the third challenge is concerned, the composition of the deficit reduction, the policymakers has to consider several factors. The rising age of the demography has raised the cost incurred by the government in dealing with the health care problems. The government has sharply reduced the spending on the health care programs and interest payments of debt, to improve the deficit in the long run. The message to the public has been clear by the government: either they have to reduce the benefits or pay higher taxes to the government. Impacts on the Lives of People The changes in the tax regime of the government can provide an incentive, for the people and business alike, to save and invest. Increase in the marginal taxes imposed on the income earned from owning capital like, taxes on dividends and wealth, would reduce the rate of saving. Another opposing force acts to increase the savings (Poulson and Kaplan, 2008). This can be interpreted by lowering of the assets value of the people, which makes them poorer and therefore, increases their incentive to save. US government expects the rate of savings to fall on account of the policy. Changes in the corporate taxes can also affect the level of investments in various forms of capital, the research and development and the level of production. Changes in the corporate taxes can alter the mode of organization of the business and the pattern of investments by the multinationals. Level of high corporate taxes can reduce the level of business of a country. The income earned and work done by the individuals can also alter significantly on account of taxes. A higher amount of tax can reduce the incentive of work for any average person. However, it might simultaneously provide an incentive to work more in order to maintain a certain standard of living. The changes in the level of government spending can also affect the output produced by the economy. A reduction in the social security spending by the government severely affects the individuals, who were enjoying the benefits previously. The cuts in spending on priority areas can reduce the output. The shutdown of the government in the recent times has greatly reduced the output and its effects can be clearly felt from the falling GDP. The shutdown can have both direct and indirect effects on the macro economy. The government started to face the funding gap from the beginning of October. The shutdown in the growth had reduced the output directly; it had also indirectly affected the total demand because the purchases made by the government sector from private sector could not be made as well. The reduction in supply could not be reversed as it represents the number of working hours that has been lost. However, the loss in demand was temporary as delayed purchases of the goods were made. The indirect effects of the government spending came in terms of the multiplier that is associated with the spending cuts (Labonte, 2013). The federal servants had no option but to reduce their spending during the crisis, the delayed spending had impacted the GDP. The small business backed loans were also affected by the shutdown temporarily. The shutdown of the government could have also reduced the confidence of the investors in the financial markets because of the uncertainty in the political scenario. These factors collectively acted as a blow to the financial recovery of the country and slackened the GDP growth. The employment figures went on huge fluctuations due to the temporary layoff. Conclusion This study has primarily been concerned with the fiscal policy measures in the United States of America in the recent times. The study reveals the types of fiscal policies that have been adopted in USA, recently, to deal with the recession and economic slowdown. The analysis has revealed that the government had changed its fiscal policy from expansionary to contractionary for dealing with the recession in the present time. The reason for this and the challenges faced by the government in making the painful adjustments has been discussed. The study has particularly concentrated on the shutdown of the federal government in the last quarter of 2013 and has discussed about the direct and indirect consequences on growth. It has been observed that the recent federal shutdown, though for a short period, has slowed down the pace of recovery of the economy. The direct impact was the reduction of the GDP on account of the lay-off of the federal workers. The indirect impact came from the multiplier effects of the government spending cuts. The employment figures were also affected owing to the shutdown and resulted in the loss of investor confidence. Reference List Burnt Hills-Ballstan Lake, n.d. Expansionary Fiscal Policy. [online] Available at: [Accessed 30 December 2013]. Elmendorf, D. W., 2011. Confronting the Nation’s Fiscal Policy Challenges. [pdf] Congressional Budget Office. Available at: [Accessed 30 December 2013]. Horton, M. and El-Ganainy, A., 2012. Fiscal Policy: Taking and Giving Away. [online] Available at: [Accessed 30 December 2013]. International Monetary Fund, 2013. IMF Policy Paper Reassessing The Role And Modalities Of Fiscal Policy In Advanced Economies. [pdf] International Monetary Fund. Available at: [Accessed 30 December 2013]. Kopits, G. and Symansky, S. A., 1998. Fiscal policy rules. Washington D.C.: International Monetary Fund. Labonte, M., 2013. The FY2014 Government Shutdown: Economic Effects. [pdf] Congressional Research Service. Available at: [Accessed 30 December 2013]. Lucking, B. and Wilson, D., 2012. U.S. Fiscal Policy: Headwind or Tailwind? [online] Available at: [Accessed 30 December 2013]. Mutikani, L., 2013. Fiscal policy fight may dampen U.S. economic growth: Reuters poll. Reuters, [online] 13 October. Available at: [Accessed 30 December 2013]. Poulson, B. W. and Kaplan, J. G., 2008. State Income Taxes and Economic Growth. Cato Journal, [e-journal] 28(1). Available at: [Accessed 30 December 2013]. Prante, G., 2013. A Distributional Analysis of Fiscal Policies in the United States. [pdf] Tax Foundation. Available at: [Accessed 30 December 2013]. Appendix Fiscal policy fight may dampen U.S. economic growth: Reuters poll BY LUCIA MUTIKANI WASHINGTON Thu Oct 17, 2013 10:03am EDT National Park workers remove a barricade at the Martin Luther King Jr. Memorial as it reopens to the public in Washington October 17, 2013. CREDIT: REUTERS/KEVIN LAMARQUE (Reuters) - U.S. economic growth this quarter is likely to be less robust than forecast last month given the erosion of confidence in the wake of the nasty fight over fiscal policy, a Reuters survey showed on Thursday. The fourth quarter had been expected to mark the transition to a stronger pace of expansion. But economists have grown less optimistic after the budget tussle that shut down parts of the government and left the nation flirting with a historic debt default. "The insanity in Washington is affecting consumer and business confidence. That's the huge restraint to growth," said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. The survey of over 70 economists taken from October 11 right up until Wednesday, when a last-minute deal ended the budget standoff, forecast GDP growth at a 2.3 percent annualized rate in the October-December quarter. While that was only marginally lower than the 2.5 percent economists had estimated in September, the risk is high that growth could come in even lower since the shutdown of the federal government lasted longer than the one week that many economists had expected. The shutdown, which started on October 1, was estimated to chip away around 0.3 percentage point from annualized fourth-quarter gross domestic product. The government is expected to reopen soon, after the U.S. Congress approved an 11th-hour deal to temporarily fund the government and raise the country's borrowing authority until February 7. Growth for the first quarter of 2014 is seen at a 2.6 percent pace, unchanged from last month's survey. Some economists, however, say this forecast is optimistic given that the fiscal policy tension in Washington remains unresolved. "The damage has been done, political wrangling will continue, and the Fed is likely to delay its tapering plans," said Jan von Gerich, strategist at Nordea. Concerns about the economy's near-term outlook suggest the Federal Reserve will not be in a hurry to start scaling back its massive monetary stimulus. The U.S. central bank surprised markets last month by saying it would continue its monthly $85 billion bond purchases, and the consensus was then for a move in December. Now, 45 of 72 economists said the Fed would only scale back its stimulus in the first quarter of next year, with another three saying they will wait until the second quarter. Twenty-four still expect the Fed to taper by the end of this year. "It takes tapering off the table this year," said Ryan Sweet, senior economist atMoody's Analytics in West Chester, Pennsylvania. "They will not have to revisit (the debt ceiling) until February. That delays the tapering until March. The Fed is not going to take any chances." WEAKER JOBS GROWTH AS A RESULT The economy will take a direct hit this quarter from the shutdown through the loss of output from the federal government, which makes up 7.5 percent of GDP. It has been a drag on growth since the fourth quarter of 2010, with the exception of only two quarters. Yet despite its small size in the economy, a sharp drop in government spending resulted in growth stalling in the last three months of 2012. The closure of the government will also have an impact on consumer spending. Hundreds of thousands of federal workers were furloughed during the closure. While these workers will have their salaries paid retroactively, their counterparts in the private sector will not. That will hurt already weak income growth and put a damper on what has so far been sluggish consumer spending. And the shutdown has already dented confidence. The Thomson Reuters/University of Michigan index of consumer sentiment hit a nine month low in early October, a worrying sign ahead of what is shaping out to be lackluster holiday shopping season. A survey by the National Retail Federation this week showed Americans, concerned but the economy and the uncertainty over the government budget, were taking a conservative approach to holiday shopping. Spending on gifts and holiday decor this year was expected to be two percent less than in 2012. Separately, the New York Federal Reserve's general business conditions index, which gauges factory activity in New York state, touched a five month trough in October. "The recovery is on hold for another four months," said Gennadiy Goldberg, an economist at TD Securities in New York, citing the unresolved differences in Washington over the government budget. "Hiring and investment decisions that have been plagued by political uncertainty will persist, and the hoped-for shift higher in economic momentum will be delayed." The median forecast for non-farm payroll growth is to average 151,000 a month in the third quarter, followed by 175,000 in the current quarter. Those mark the lowest expectations for these periods in a year. (Additional reporting by Swati Chaturvedi in Bangalore; Analysis and polling by Sarbani Haldar and Rahul Karunakar; Editing by Ross Finley and Hugh Lawson) Read More