Economic Foundation for Finance FR1001 - Essay Example

Economic Foundation for Finance FR1001 Table of Contents I. Introduction ……………………………………………………………… 3 II. GDP Trend of US ……………………...………………………………… 3III. Indicators of Slack or Overheating ………………………………………. 9 IV. High Unemployment Rate ……………………………………………….. 9 V. Balance of Payment ……………………………………………………… 10 VI. Monetary and Fiscal Policy ……………………………………………… 11 References ……………………………………………………………………….. 13 Introduction Macroeconomic study aims to understand the factors that determine the aggregate trends in the economy focusing primarily on the national income, unemployment rate, inflation, investment, and international trade. (Wikipedia, 2007a) Macroeconomic tools are used to guide us in understanding causes and consequences of short-run fluctuations in the national income as well as the long-run economic growth. Two types of strategies used in macroeconomics include the fiscal and monetary policy. These two are used interchangeably to avoid major economic shocks like the great depression. Governments are controlling the fiscal policy to stabilize and maintain the flow of the economy. This way, a country can achieve economic stability and growth. In United States, the government controls the fiscal and monetary policy in order to achieve a good economic development. Economy is good in case of low unemployment rate, low fiscal deficit, controlled inflation rate, high gross domestic product (GDP), maintained exchange rate, high export and low import of goods, balanced cash inflows and outflows, and a good investment portfolio. GDP Trend of US Based on the graph below, the US output gap between the early 1980s up to the last quarter of 1984 and 2001 to 2006 is negative. The worst recent output gap of US was back in 2003 when they have reached negative 1.1. With the proper use of fiscal and monetary policy, despite the Asian crisis in 1997, the US was able to control inflation rate and the fluctuation of exchange rates. The control of inflation resulted to a more stabilized prices and economic growth. The negative output gap is most likely to be the after effect of the high inflation and interest crisis in 1980s, Mexican crisis in 1994 and globalization in year 2000 onwards whereby many of the US businessmen started to cut on their operational costs by subcontracting most of their needed services from the skilled workers from developing countries. The US is aiming to reach a zero output gap by year 2008. (IMF, 2007) Source: International Monetary Fund – World Economic Outlook 2006 Source: Wikipedia Since most of these businessmen are downsizing their businesses in US back in the early twentieth century, many of the US local citizens were affected by mass lay-offs. Some companies even had to declare bankruptcy because of the tight competition coming from the global markets. The increase in the unemployment rate affects the consumer spending in the long-run. This is the main reason why the real domestic output of the US has been constantly declining since 1999. (See Table 1 below) Table 1 - Advanced Economies: Real GDP and Total Domestic Demand United States     2007 2006 2005 2004 2003 2002 2001 2000 1999 1998   Real GDP 2.9 3.4 3.2 3.9 2.5 1.6 0.8 3.7 4.4 4.2   Real Total Domestic Demand 2.9 3.4 3.3 4.4 2.8 2.2 0.9 4.4 5.3 5.3 Source: International Monetary Fund – World Economic Outlook 2006 Notice that the graph above indicates that the US has experienced having the lowest real GDP output in year 2001. Even the total domestic demand at that time has reached its lowest point. This is because of the insufficient money that has been circulating in the US around those times. Most of the US$ were invested in foreign business during those years because of the globalization. After the year 2001, the US has started to earn money from their foreign investments. Some of these business people started bringing the money back to their mainland, US. Notice that even the consumer expenditure is also affected by the globalization. Since 2001, the private consumer expenditure has slide down into half as compared to the 1998 expenditures. This data clearly shows that the local citizens are holding tight on their cash rather than investing it in businesses. Slowly, the private consumer expenditures is gradually increasing again because of the fact that most of them has already recovered or adjusted from the after effect of globalization. (See Table 2 below) Table 2 – US Private Consumer Expenditures & Public Consumption United States     2007 2006 2005 2004 2003 2002 2001 2000 1999 1998   Private Consumer Expenditure 2.6 3.0 3.5 3.9 2.8 2.7 2.5 4.7 5.1 5.0   Public Consumption 2.2 1.6 0.9 2.1 2.5 4.3 3.1 1.7 3.1 1.6 Source: International Monetary Fund – World Economic Outlook 2006 Since the local businesses in US at that time were on its lowest point, the government collect taxes have also decreased a lot. These taxes normally come from the local businesses as well as personal income taxes. Despite the fact that the real GDP has slowly been increasing since 2001, tax collection remains lower than the normal rate of government expenditures. The US government has no choice but to borrow money from the Central Bank or sell some of its T-Bills in order to finance the daily government expenditures. The US General Government Fiscal Balance started to reach a negative level in 2001. The US Central Government Fiscal Balance was also affected starting in 2002. (See Table 3 below) Table 3 - US General & Central Government Fiscal Balance United States     2007 2006 2005 2004 2003 2002 2001 2000 1999 1998   Gen. Govt Fiscal Balance -3.2 -3.1 -3.7 -4.6 -4.8 -3.8 -0.4 1.6 0.9 0.4   Central Govt Fiscal Balance -2.8 -2.5 -2.9 -3.7 -3.8 -2.6 0.4 1.9 1.1 0.5 Source: International Monetary Fund – World Economic Outlook 2006 Basically, demand is weak when the local US citizens do not have enough money in their pocket. This is due to the high unemployment rate that resulted from globalization. Indicators of Slack or Overheating When a country is experiencing ‘overheating’, normally there is a high inflation rate in the country. The Federal Reserve is doing its job pretty well in preventing the US economy from ‘overheating’ by controlling the interest rates of US dollars. Back in 1994, the Federal Reserve increases the interest rates in US to avoid overheating during the Mexican economic collapse. (Surin, 1998) High Unemployment Rate Normally, when there is a high unemployment rate, fiscal policy can be used. For example: the Unemployment Insurance in US. The Unemployment insurance scheme now known as the Unemployment insurance (UI) is a federal program in U.S. which provides a maximum of 53 weeks period of income benefits to the US citizens who are unemployed. As soon as a US citizen loses his job, he can automatically claim the ‘regular unemployment insurance’ for up to 26 weeks of benefits. In case he still could not find a job, he could claim the ‘temporary unemployment compensation’ (TEUC), then the ‘extended benefits program’, and the ‘state funded additional benefits.’ (Coven, 2003) The main objective of this policy is to increase the opportunity cost of those US citizens’ who are unemployed and to reduce the cost of working by mobilizing the unemployed people to look for a job. It is believed that this policy will help unload the burden on low-skilled laborers as well as improving the US public employment agencies. Lowering down the corporate taxes could attract more investors to do business in US as well as making the goods and services affordable and competitive in the global market. This will create more employment opportunity for the people. It is not bad for the government to intervene. However, too much of it can cause inflation. Also, increasing the US government expenditure will create job. Therefore, unemployment rate decreases. (See figure 1 below) A temporary increase in government spending will create job opportunity. This causes the LM1 curve to move to LM curve. The increase in the labor will eventually result to a decrease in wage and salary (W) and the real interest rate. Balance of Payment Balance of payment is simply referring to international transactions. The import and export of goods has to be balanced. Failure to do so will cause either a surplus or deficit in the merchandise trade, services, investment income, unilateral transfers, official reserve assets, etc. Basically, imbalanced cash flows will result to changes in the interest rates and exchange rates. Such that when the outflow is more than the inflow, the purchasing power of the money will generally decrease and the interest rates will increase. (Stein, 2007) The US Balance of Payments as of the last quarter of 2006 is negative. (Haver, 2007) This is due to the depreciation of the value of US dollar which causes their importation to be more expensive compared to a stronger US dollar. Therefore, there is an imbalance in the cash inflows and outflows. (See Graph below) Monetary and Fiscal Policy Lately, the Federal Open Market Committee is responsible for the US monetary policy. (FRB, 2007a) They control the interest rates in order to maintain a low inflation rate. It is their sole duty to ensure that overnight US dollar interest rates are avoided. They also issue some banknotes in order to achieve a stable and sound financial system. So far, the interest rates in US are maintained at 5.25% since January to March 2007 and will only change the interest rates by mid 2007. (Huliq, 2007; Federal Reserve, 2007b) The US government is responsible in controlling the US economic activity by using fiscal policy. (IIP, 2007) In response to the effect of globalization, the US Treasury is releasing tax relief to millions of American Families. Also, they have structured the local tax collection in a way that the rich people pay more taxes than the lower income earners. This way, the distribution of income among the Americans would be balanced. (US Treasury, 2007) Given the monetary and fiscal strategies made by the Bank of England and HM Treasury, I would recommend that the fiscal policy should include implementing a higher tax rate on imported goods. This will encourage the local people to patronize their own manufactured goods and services. This is one of the best ways to address globalization. Maintaining good exportation performances while keeping the importation of goods at a minimum level is the best strategy. This way, the demand of goods within our country will increase. This will create more job opportunity for our local people. ***End *** References: 1 About ECB (2007) ‘ European Central Bank’ Retrieved: April 2, 2007 < http://www.globalguide.org/ > 2 Coven, M. (2003) ‘Introduction to Unemployment Insurance’ Retrieved: April 3, 2007 < http://www.cbpp.org/ > 3 Federal Reserve (2007a) ‘Monetary Policymaking: FOMC’ Retrieved: April 3, 2007 < http://www.federalreserve.gov/ > 4 Federal Reserve (2007b) ‘Selected Interest Rates’ Retrieved: April 3, 2007 < http://www.federalreserve.gov/ > 5 Haver (2007) ‘Negative Net Income: The 2006 Balance of Payments’ Retrieved: April 3, 2007 < http://www.econbrowser.com/ > 5 IIP (2007) ‘Monetary and Fiscal Policy’ Retrieved: April 3, 2007 < http://usinfo.state.gov/ > 6 IMF (2007) ‘Statistical Appendix’ Retrieved: April 2, 2007 < http://www.imf.org/ > 7 Pravda RU. (2006) ‘US Federal Reserve to Change Interest Rates Only in Mid 2007’ Retrieved: April 3, 2007 < http://www.huliq.com/ > 8 Stein, H. (2007) ‘Balance of Payments’ Retrieved: April 2, 2007 < http://www.econlib.org/ > 9 Surin, K. (1998) ‘Dependency Theory’s Reanimation in the Era of Financial Capital’ Retrieved: April 3, 2007 < http://clogic.eserver.org/ > 10 US Treasury (2007) ‘Tax Relief Kit: US Department of Treasury, Office of Tax Policy’ Retrieved: April 3, 2007 < http://www.treas.gov/ > 11 Wikipedia (2007a) ‘Macroeconomics’ Retrieved: April 2, 2007 < http://en.wikipedia.org/ > 12 Wikipedia (2007b) ‘Gross Domestic Product’ Retrieved: April 2, 2007 < http://en.wikipedia.org/ > 13 Wikipedia (2007c) ‘GDP gap’ Retrieved: April 2, 2007 < http://en.wikipedia.org/ > Read More