The Impact of the Federal Reserve on the Elections 1992 - Term Paper Example

The impact of the Federal Reserve on the elections in 1992 Presented The impact of the Federal Reserve on the elections in 1992 The Federal Reserve Board, Fed is the body mandated to regulate economic dynamics in the country through raising or lowering interest rates in the market, to offer an impetus to the economy in minimizing recession. There has been a trend where the Federal Reserve is under much pressure from the political actors to act in a predetermined way, to reduce recession, making it favorable for the political actors to have their way into office with precept of acting to improve the economy.1 In 1992, Fed reduced short term interest’s rates to check recessionary forces in the market. This led Federal Reserve board to make small reduction on short term interest rates, 1 perhaps with the confidence that such reduction was to be mild and brief. According to an News Times report, FED trimmed Federal Fund rates that banks charge one another for overnight loans from 6% to 5.75%, with the discount rate ,which Fed levies on banks for short term loans remaining constant at 5.25%.1However, the effects of interest rates are usually not realized immediately, and take time to be felt in the market.2 The delayed actions by Fed in lowering interests rates were therefore not realized immediately upon the interest cuts; recession was increasing rapidly, and as people have increasing hope in the policies of an opponent in such cases, Clinton’s economic policy in 1992 election were magnified by Fed delayed actions, with studies portraying the electorate as preferring Clinton to Bush. 3There have been discussions on the effectiveness of this intervention in the market by Fed in 1992, where many analysts have termed the intervention as too late and too little in terms of stimulating the economy; with many analysts arguing the intervention resulted to increasing inflationary rates in the economy as long term interest rates remained persistent.3 Despite reduced interest rates to encourage borrowing, fed interference in the economic dynamics resulted to increased inflationary rates, which were evidence after the elections. To deal with growing public spending deficit, the top marginal income tax rate was raised from 31% in 1992 to 39.6% in 1993, which was similar to a 42.55 increase when Medicare tax hikes were included. 4This was proved by the economic growth that was recorded at 4.3% annually in the last quarter of 1992, but dropped to 1.7% annual rate in first quarter of 1993. 4 This reduced growth was a result of long term interest rates that continued to haunt the economy; the high interest rates were shelved in 1992 when they were supposed to be leveled and transferred to 1993, explaining the slowed growth. Seib in an article on Clinton woes noted, “even though the year opened with the economy growing at better than that magic 4% annual rate, Clinton’s job approach rating dropped steadily.5 “A wall Street journal/NBC news poll showed that a large group of electorate, by 11point margin preferred republicans in handling the economy, as compared to democrats under Clinton.”6 This was because; the effects of the interest rates slowed down growth, despite the intervention by Fed in lowering interest’s rates. “When interest rates rise, concerns about the present state of the economy, and doubts about the future increase as well”7 These doubts, supplemented by an oncoming national elections in 1992, might have resulted to the stagnating economy that declined towards early 1993. The effectiveness of fed intervention was thrown to more doubt by Mr Greenspan, the Fed’s chairman, when he hinted that he was reluctant to stimulate an economy he considered good in shape for long term.1 The budget cuts had negative effects on investors, companies, and the overall economy. “Anemic growth of the nation’s money supply cited by the Federal Reserve in its latest rounds of interest rate cuts also worries many forecasters; so do the huge debt burdens of individuals, companies and governments, as well as higher state and local government taxes.” 8The cuts resulted to increased uncertainties, with chances of erosion of the gains recorded in economic growth in 1992 being increasingly possible.8 Between May and June in 1992, unemployment rate raised from 7.55% to 7.8%, with high drops in the number of employees in business payrolls, meaning that businesses were heavily loosing, with the federal interests rates being defined as “too little too late.”8 The economy was in terrible shape, and many analysts forecasted slowed growth rates amidst massive tax cuts to all time lows. Many economic analysts remained skeptical to fed’s intervention, “the 1992 recovery is a one legged recovery. It cannot run or sprint because, in contrast to nearly all preceding recoveries, federal taxes have risen, and are continuously rising along with state and local taxes.”8 Therefore, there was a general perception that short term interest’s rate cuts were not enough to stimulate the economy. In evaluating whether a tax cut would be more appropriate or not for the economy, there was a need to ask one important question; “should a fiscal policy be used to encourage consumers to spend more or to spend less?”9 While one argument is based on short term demand management, the other is based on long run economic growth. Under the Keynesian principle, fiscal policy is more applicable in combating recessions.9 Tax cuts were supposed to stimulate consumer spending, raising demand for products in industries, and aiding the economy out of recession; Laffer curve suggests “higher taxes lead to lower levels of specialization, and lower economic efficiency.”10 Mankiw further argues tax cuts in stimulating consumer spending would make Fed less willing to lower interest rates, and Fed would have used monetary policies to counteract the stimulus achieved through tax cuts.9 The use of consumption taxation instead of income taxation was suggested as the best way to approach the issue of recession in 1991.11 Generally, paying taxes on what consumers spend, and not according to their earnings would encourage savings, while the budget deficit would remain intact. Such an approach would have benefited the economy for long term, and not short-term basis, though it could have reduced consumer spending. (Source: Anonymous, n.d) The figure above shows the aggregate demand to aggregate supply trends in a recessionary economy, as the case was in 1992. The flat region of the aggregate supply curve represents the slack or excess capacity built in an economy in recessionary, and weak economic growths.12 The equilibrium point marked as Y* is to the left of Yf, which indicates full employment, consistent with levels of unemployment, where those wishing to work have jobs. Full employment is considered as a case where an economy is reaching full capacity utilization, or has a potential output.12 However, changes in either monetary or fiscal policies has little or no impact on the rate of change of aggregate supply rate in the short run; raising doubts on effectiveness of the short term interest cuts by Fed on the economy in 1992.6 Taxes act as trade barriers in the economy, in preventing participants in such an economy from participating in more efficient means to satisfy needs. These are the effects that result to high unemployment rates, and increased recession in the economy. However, in states that are aimed at reducing long term interests rates, bonds have to be bought in sufficient quantities, which would stimulate economic activities in such economy on the long term, reducing the long-term interests rates.3 Fed did not act on the long term interest rates, barely affected by these mild cuts.13 The long term interest rates after this cuts increased from 2% to in excess of 4%; which was a historic high in the US economy. 13The result was increased unemployment rates in the economy. The deficit hangover and an employment rate of about 7.7% were the effects of the short term interest cuts by FED, mainly fueled by a stagnating economic growth that had been inherited from the past decade.12 The financial markets in this case added an inflationary premium to the prevailing long term interest rates, and as these long term interest rates remained unmoved, unemployment rate, and public spending remained at all time high levels. Fed utilizes open market operations to implement its policy decisions, through changing the percentage of reserves that banks have to keep. When fed lowers the reserve requirement as part of expansionary monetary policy, banks will have additional money to lend to businesses and other consumers. The net effect of such actions would be to increase the money in supply, lowering the interest rates, and increasing the GDP rate. However, during the 1992 elections, fed lowered short term interest rates, but the hanging impact of long term interests rates carried over from the previous decade was still prevalent; meaning that the economy could not have been stimulated in improving GDP, leading to a stagnated economy. The effects of stagnated growth could have an impact on electorates’ perception regarding the 1992 elections. The rising unemployment and uncertainty in the economy discouraged investors from producing, resulting to low supply, which was responsible for increased inflationary rates after the election. Work Cited 1. Bradsher, Keith. “Federal Reserve trims a key a rate; first cut since 1992.” New York Times. 1995, July 7. http://www.nytimes.com/1995/07/07/us/federal-reserve-trims-a-key-rate-first-cut-since-92.html 1st march, 2012 2. Roubini, Nouriel. Supply Side Economics: Do Tax Rate Cuts Increase Growth and Revenues and Reduce Budget Deficits? Or Is It Voodoo Economics All Over Again? Stern School of Business, New York University, 1997. http://people.stern.nyu.edu/nroubini/SUPPLY.HTM 1st march, 2012 3. Mayer R. Kenneth. Electoral cycles in federal Government prime contract awards: state – level evidence from the 1988 and 1992 presidential elections. American Journal of Political Science. 39.1 (1995), 162-165.pg 167 4. Wesbury S. Brian and Stein Robert. “Disagreeing with Laffer.” Forbes. 2010, June 15. http://www.forbes.com/2010/06/14/taxes-arthur-laffer-economy-opinions-columnists-brian-wesbury-robert-stein.html 1st March, 2012 5. Seib, F. Gerald. “Clinton’s woe economy hums the polls sag.” The Wall Street Journal, August 3, 1994. Proquest 1st march, 2012 6. DeBoef Suzanna and Kellstedt M. Paul. The political (and economic) origins of consumer confidence. Harvard. www.iq.harvard.edu/files/iqss/old/.../kellstedt.pdf, 1st march, 2012, pg4 7. Ibid, pg 8 8. Herman, Tom. “Economy: Analysts predict a barely noticeable recovery dire unemployment figure for June.” Wall Street Journal 1992, July 6. Proquest. 1st march, 2012. 9. Mankiw, Gregory. “Wrong time for tax cuts.” Wall Street Journal 1991, Oct. 31. Proquest. 1st march, 2012 10. Case, E. Karl and Fair, Ray. Principles of Economics (8th ed.). Upper Saddle River, NJ: Prentice Hall, 2007, pg 781 11. Lindgren, April and Dowling, Deborah. “The economy is by far the biggest issue among voters in the Oct. 25 federal election.” The Ottawa Citizen, 1993 Oct. 3.Proquest 1st March, 2012 12. Anonymous. Principles of Macroeconomics. The Business cycle, aggregate demand and aggregate supply. n.d http://www.colorado.edu/Economics/courses/econ2020/section7/section7-main.html1st march, 2012 13. Vogel Thomas. “Dollar, politics are unsettling bond investors: credit markets.” Wall Street Journal, 1992 Sept. 8 Proquest. 1st march, 2012 . . Read More