The Current Economy and Where We Are Headed - Essay Example

The Current Economy and Where We Are Headed

• Introduction

The US economy is still the largest and most important in the global landscape in spite of having a history of severe economic downturns. Dating back to 1929, the US economy was shaken by the Great Depression, which had literally stalled the economic progress of the feral nation. The US economy only saw its first rising trend in GDP (Gross Domestic Product) in 1942. There were many factors that contributed to the change of a recession into a “Great Depression,” such as a crash in the stock market, increase of the Smoot-Hawley tariff, faulty Federal Reserve policy, failure of the banking sector and end of the standard of gold in both the UK and the US (Hall and Ferguson, 2009). The expenditure taken by the US government under Roosevelt, while preparing for World War II, gave the required stimulus to recover the economy from the clutches of the Great Depression (Rosen, 2012).

The US economy is still occupying the leading position in the world market. The producers in the US are responsible for 20% of the global outputs and the US economy offers the sixth highest per capita GDP (PPP). It is dominated by the service sector, although it occupies the position of second largest manufacturer in the world. The Depression of 2007-08 shook the economic stability of the federal nations but it has not been able to keep the spirit of the economy in shackles for long (Focus Economics, 2016). The economy is already in the path of recovery and measures have already been taken by the US government. The main question is whether the US economy will be able to be back on its path of progression or will it topple back to recession. The current situation along with the expectations of economic analysts shows that, the US economy is eying on long-term stability which can slow down the economic growth of the nation for the upcoming 2 years.

• Economic Factors Affecting US Economy

The factors that have the potential to affect the economic situation of the US are interest rates and expected change in higher inflation rates. The US economy is still recovering from the depression of 2007-08 through quantitative easing. This technique consists of two parts. The first part includes low interest rates. In the second part, there is an order for an increase in money supply within the economy, where the federal government seeks to purchase a large sum of financial assets as the other part for the sake of quantitative easing. The inflation rate has been on a rising trend in the US economy since the early 2016. This continuous rise in prices is expected to affect the demand and supply of the US market (Reuters, 2016a).

• • Effect on Aggregate Supply and Aggregate Demand

When the interest rates are lowered, it affects the economic activities. Low rates of interests, lowers the cost of investment in the long-run. This simultaneously reduces the cost of major products like, cars, houses, bigger appliances. When an economy is able to produce products at a cheaper rate, then people tend to buy more goods. The aggregate demand (AD), as a result, rises shifting the AD curve in the rightward direction.

The rising inflation rate causes the consumers to purchase products in the current period instead of buying at a later date, because they wish to get their required commodities at a cheaper price, thus increasing the overall demand of the product. On the other hand, aggregate supply (AS) will not increase similar to the aggregate demand, because the producer would like to wait for the prices of the products to increase further, so that they can earn higher profits. Hence, the shift of AS curve to the right will be less than that of the AD curve.

(Source: Author’s creation)

D1 and D2 represent the original and shifted aggregated demand curves while S1, S2 and S3 represent the aggregate supply curves. If AS increases according to the increase in AD, then the new Supply curve will be S3, thus resulting in a lower price and higher quantity. However, the producers allow the price to rise further to P2 by controlling the AS.

• • Labour Market

The current situation with the labour market in the US is providing hope to the labour force of the US economy. The unemployment rates have been stabilized at around 5% (Reuters, 2016b). The prospect of lower investment cost in terms of long term projects also provides the hope for increasing job opportunities as well as rise in the wage rate. However, due to limited increase in the short-run supply, labour demand curve is expected to shift to the right only a little in the short run.

shcurrent supply condition for labour.

(Source: Author’s Creation)

If the producers have increased their production according to the AD of the US market, then the actual shift in the labour curve would have been D3, but they are expected to increase their production by a limited quantity, hence, resulting in the shift of the labour demand curve to D2. This also indicates that the wage of the labour force is expected to rise up to W1, instead of W2.

• • Effect on Money Market

Lower interest rates increase the money demand in the US economy causing a movement along the money demand curve, whereas the increase in the level of price will cause the money demand curve to shift towards the right. The money supply is determined by the Federal Reserve and the policy of lowering rate of interest can be further achieved, by increasing the money supply in the economy.

Figure 3: Effect on the Money Supply and Demand

(Source: Reinert, 2011)

The interest rate can be fixed by the Federal Reserve through the control of money supply. In the above figure, the Central Bank has chosen to keep the interest rate fixed at 6% by keeping the money supply at $500 billion. However, if the interest rate decreases then, it will directly create an impact upon the rise in demand for money.For example, if the interest rate lowers from 6% to 3%, the aggregate money demand will rise because of increse in investment from the producer’s end.

After going through the above sections, it can be said that if the US economy chooses to keep its interest rates low and allows the inflation rate to continue with its rising trend, then in the short run (say, for 1 year) the economy is bound to experience a lower GDP growth. The producers expecting to reap higher profit by selling at higher prices will result in a limited increse in the total output hence, resulting in a sluggish GDP growth.

• Evidence

Figure 4: Projected Interest Rate Trend

(Source: Trading Economics, 2016a)

According to the trade analysts and data published by the US Federal Reserve, the trend of interest rate in the US economy has been 1%, which is expected to remain unchanged in 2017, but the tightening of the labour market is an indication that the interest is expected to increse by 2020. However, the Chairperson of the Federal Reserve, Janet Yellen has predicted that the American economy was not impending towards recession by putting the probability of a recession at 10% which was contradicted by the economists’ survey conducted by the CNN (a popular news channel) stating that, the chances of a recession in the US economy is as high as 18% (CNN Money, 2016). Such results have influenced the economy’s decision of changing its interest rate in the near future.

The US economy has shown a trend of inflation, such as increase in the rents and the medical costs. Builders in the US economy are facing a shortage of skilled workers resulting in higher rents in the metropolitan areas of America. The fall in oil prices represented that there can be a deflationary effect round the corner, but Fed officials have deemed it to be a transitory factor and the economy is expected to continue with the higher inflation rate (CNBC, 2016).

The Labour Department of the federal government has revealed the consumer price index, which has attained a positive growth since January, 2016. The cost of clothes has even increased (Reuters, 2016a).

Figure 5: Trend in Inflation Rate

(Source: Trading Economics, 2016b)

• Possible Changes in the US Economy

The US economy is expected to experience a slowdown for the next couple of years, but in the long run, the policies of low interest rate and relatively rising inflation rate are expected to yield high growth of GDP. The policies undertaken by the US government have been scheduled for long–term stability and growth. In the short run (Here, one year), it is not possible to earn increasing returns immediately. The producers will keep their production aligned to the rising price level so as to reap more profits. Hence, within a period of one year, changes will be realized from the demand side of the market with a sluggish end of supply.

• Effect on Monetary and Fiscal Policy

Money supply is supposed to increase. The US government, as part of its recovery program, has provided for large sums of tax cuts leaving more money in the hands of the citizens, and this lower interest rate policy will affect the rising aggregate demand. The recession in 2007-08 has left the federal government to recover the growth rate. This has necessitated the government to undertake expansionary fiscal and monetary policies. As a part of the fiscal policy, the government has increased its expenditure and has allowed huge tax cuts. Moreover, to encourage the producers the government has allowed the inflation rate to rise. On the other hand, as a part of the monetary policy, US government has kept the interest rate near its lower boundary even though Federal Reserve has denied any impending recession. More money in the hands of the people is bound to increase aggregate demand and due to limited increase in the production the price level is expected to rise, thereby increasing the inflation rate.