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Sample Research Paper on Monetary and Fiscal Policy

Recession and the current state of the US economy

Recession is economic slowdown which is marked by a decline in spending leading to fall in macroeconomic indicators such as GDP, employment, investment spending, household incomes, industrial production , wholesale and retail sales and inflation.  It is also cyclical in nature.  The National Bureau of Economic Research (NBER) defines inflation as a period when demand gets contracted for the two consecutive quarters.

In 2008-2009, the US economy along with the world economy went through what is famously called as economic slump.  More than  8 million jobs were lost during the period , the major reason was subprime mortgage that affected the nation in late 2007. The longest ever recession went on 18 months beginning from December 2007 to September 2011 , according to the Federal Reserve . However , the recent trends suggest the US economy is again in recession or may be going in for a recession largely due to slackening of demand world wide and rising unemployment rate. (Trading Economics )According to US president’s remarks in the 2012 budget , he states as much when he says, “But we are not out of the woods yet.” (US Government). Incomes are not rising while the consumption levels are slightly up. Jobs are not getting created which is turn means  the economic activity is at a stand still. There is growing worry about the fiscal cliff which is a bone of contention between the democrats and conservatives in the US Congress may lead to  collapse in the US economy. Fiscal cliff is a dispute between the President Obama and the congress on how to manage the country’s $15 trillion of debt without hurting the US economy. The confirmation has come as recently as in May , 2012. The Congressional Budget Office (CBO) report says, that the US economy is likely to shrink by 1.3 %  in first half of 2013 if the budget cuts and tax increases proposed by the congress are applied in the near term. The US congress has proposed $1 trillion  in spending cuts which will be applicable from early next year.

Fiscal policy tools which can be used to stimulate the US economy

Fiscal policies available to government are two : 1. Increase government spending ; 2. Lower the taxes. The policy is used to boost the economy especially during the period when consumer spending is at a lower level. In the present context this can be done only be increasing the deficit.

Recommendations:

  1. We should continue to keep tax cuts to allow consumers to spend more. It is also recommended that we provide for business payroll tax cuts. According to CBO data, every $1 billion in cuts here has created 13000 more jobs.
  2. Domestic deep sea oil drilling must be allowed to lower the energy prices.
  3. Reduce the capital gains tax
  4. Reform the financial markets (CBPP)
  5. Instead of bail outs  and financial stimulus we need spending on building social and economic infrastructures –public works – which will boost the economy.  The CBO says, for every $1 billion spent 19000 jobs can be created.
  6. The President should put an end to political commitments abroad including defense spending ,i.e. In places like Iraq, Afghanistan and Pakistan. (CBPP)

Suggested Changes in Specific areas of the  2011  budget proposals

National defense spending, some of which is spent abroad can surely reduce as it according to CNO creates very fewer job opportunities than nay other sector in the economy. It provides 8,555 jobs while the public works can give 19000 jobs. His proposal for billion dollar cut in spending in  education , housing and infrastructure sector need to be rectified.  Budget for transportation need to be more while the 2011 proposal it has remained stagnant. Tax breaks which the proposal seeks to do away with, has to be continued to boost the economy. (New York Times)

Advise to Federal Reserve

The two tools which the Federal Reserve can use to stimulate the economy and increase economic  growth are:

  1. Purchase of mortgage securities , especially to revive the housing sector
  2. Fix minimum level of interest rates on bank reserves

The US economy which remains weak despite of continuous stimulus measures such as operation twist and zero borrowing interest rate strategy need a fresh look from the economist’s point of view.

While the Federal Reserve has spent a lot of money to revive the markets. However now the focus needs to be on the purchase of mortgage  securities. The move is urgent as the unemployment is expected to climb up to 13%  by 2013 due to weak economic conditions. (D.Reilly). It is expected that the stability of the housing sector will provide a trigger to the revival of the economy.

Second,  the policy of low interest regime has failed to prompt the push industrial investment and also consumer instead of saving is focused on spending which is harmful for the future of the economy. This monetary policy tool will better serve to revive the economy than the existing measures of the overnight interest rate it charges to banks.  It will also help in controlling the inflation.

Measures to reduce inflation in terms of money supply

The major function of the Federal Reserve since inception has been a lender of last resorts. It means it will provide loans to commercial bankers who hesitate to give loans and to prod them to give loans to consumers.  Now the Fed stabilize the economy by controlling the money supply , this it accomplishes  through three tools.  1. Bank Reserve ; 2. Discount rate and 3. Open market buying  and selling in the  securities.

The money supply can be increased by decreasing the money bank needs to hold against the deposits. Second, the discount rate is the coupon rate charged by the Fed on the borrowing by the commercial banks.  In other words, if the interest rate is lower than the Fed can ensure more money supply in the market. Third, is security buying policy can also help in money supply.  When the Fed buys money supply with the consumers increase which in turn helps in increasing the consumer spending.  In the following situation the inflation can be reduced by controlling the total amount of money available in the market.  It must make loans expensive to reduce liquidity especially in the capital markets.  Some of the measures it can initiate are as follows: 1. Increase bank reserves; 2. Increase the interest rate to make loans costlier and 3. Fed now uses what is called as the inflation rate targeting which is a forecast of inflation to manage expectations of people. Also it has set what it calls core inflation rate , thus cushioning the market reactions to money supply and growth.

References

CBPP. Where do Our Federal Tax dollars go? 10 August 2012 <http://www.cbpp.org/cms/index.cfm?fa=view&id=1258>.

D.Reilly. Fed Keeps Its Finger on Trigger. 2011. 10 August 2012 <http://online.wsj.com/article/SB10001424052970203716204577014312321844008.html>.

Economics, Trading. United States GDP Growth Rate. 2012. 10 August 2012 <http://www.tradingeconomics.com/united-states/gdp-growth>.

Francisco, Federal Reserve Bank of San. 10 August 2012 <http://www.frbsf.org/publications/federalreserve/monetary/MonetaryPolicy.pdf>.

Government, US. THE BUDGET MESSAGE OF THE PRESIDENT. 10 August 2012 <http://www.gpo.gov/fdsys/pkg/BUDGET-2013-BUD/pdf/BUDGET-2013-BUD-1.pdf>.

Times, New York. Obama’s 2011 Budget Proposal: How It’s Spent. 10 August 2012 <http://www.nytimes.com/interactive/2010/02/01/us/budget.html>.

 

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