US Fiscal & Monetary Policy’s Impact on Economics

Review of the US economy

The global financial crisis had a significant impact on firms and individuals across the globe. Nations were also affected adversely. The US economy was not left out. The crisis affected various economic variables such as gross domestic products, unemployment, inflation, and interest rate among others. The table presented below shows data for the US economy.

Subject 2008 2009 2010 2011 2012 2013
Inflation, average consumer prices 215.255 214.565 218.085 224.937 229.362 233.419
Unemployment rate 5.8% 9.275% 9.625% 8.95% 8.229% 8.125%
Real Interest rate 3.10% 2.50% 2.00% 1.30% 1.50% 1.70%
Gross domestic product, constant prices (billions) 13,161.93 12,757.95 13,062.98 13,299.10 13,587.65 13,875.22

(Source of data – International Monetary Fund, 2014; The World Bank, 2014).

Discussion

The gross domestic product for the US rose from $12,757.95 billion in 2009 to 13,875.22 billion in 2013. The total increase over the period was 8.76%. A further analysis shows that there was a significant drop in gross domestic product between 2008 and 2009. The decline is equivalent to 3.07%. The economy recovered from the impact of the global financial crisis in 2011. Inflation, as measured by average consumer prices, increased from 214.565 in 2009 to 233.419 in 2013. The total increase over the period was 8.79%. Such an increase in inflation is not favorable in an economy because it affects other variables such as purchasing power and value of investment. In 2009, there was a 0.32% drop in inflation from the previous year’s value. The increase in the inflation is caused by the expansionary policies that were put in place by the State. Immediately after the global crisis, the unemployment rate rose drastically. The value increased from 5.8% in 2008 to 9.275% in 2009. The increase persisted in 2010. However, from 2011 there was a decline in the unemployment rate. The expansionary policies that were implemented were effective. This explains the reduction in unemployment. However, the economy has fully recovered in terms of unemployment because the current rate is higher than the value in 2008. A decline in the unemployment results in an increase in inflation rate as explained by the Phillips curve. Finally, the interest rate dropped from 2.5% in 2009 to 1.30% in 2011. However, after 2011, the interest rate rose from 1.30% to 1.70% in 2013. The decline in interest rate between 2008 and 2011 was a measure that was implemented to stimulate savings and investment. Thus, it can be observed that the US economy is has not fully recovered from the recession.

Expansionary strategies

Monetary policies

The first monetary policy tool is open market operations. Under this policy, the US Treasury regulates the interest rate, bank reserves, and money supply in the economy by purchasing its securities. If the Federal Reserve System purchases the securities, then there will be an increase in money supply in the economy. The second policy is the use of a discount rate. In this case, the Federal Reserve System lowers the discount rate. This refers to the rate which commercial banks are charged by the Federal Reserve System for the reserve loans. Therefore, a reduction of this rate will encourage banks to borrow money from the Federal Reserve System. This will increase their ability to lend money to the firms and households, thus, increasing money supply in the economy (Mankiw, 2011).

Fiscal policies

The first fiscal policy tool is government expenditure on finished goods and services. Examples of government spending are purchase of office equipment, furniture, and payment of salaries among others. If the government increases its purchases, then there will be an increase in consumer expenditure in the economy. This will stimulate economic growth. The second fiscal policy is the use of taxes, especially personal income taxes. An expansionary fiscal policy will entail reducing the income taxes or a tax rebate (Mankiw, 2011).

Impact of the expansionary policies on the economy

Monetary

The two expansionary monetary policies cause an increase money supply in the economy and a rise in money supply will cause a decline in the interest rates. Further, a fall in the interest rates will reduce the cost of borrowing. This encourages borrowing. In addition, an increase in borrowing stimulates investment and consumer spending and this will stimulate production and in turn increases the employment level. Therefore, it can be noted that the unemployment level will fall. An increase in money supply in the economy raises the level of inflation (Mankiw, 2011).

Fiscal

An increase in government spending will stimulate more production because of the additional allocations. Further, an increase in production will stimulate growth of income and in turn increase the level of employment in the economy. This will reduce the unemployment rate. Further, an increase in income will cause a rise in the rate of inflation. A reduction in taxes will increase disposable income and increase consumer expenditure. This will have the effect of increasing production and in turn raises the employment level in a country. In addition, an increase in disposable income creates inflation. In both cases, there is an increase in production. If the level of production increases, then the demand for money will rise. Since there is no growth in money supply, then an increase in demand for money will accelerate the growth of inflation rate (Mankiw, 2011).

References

International Monetary Fund. (2014). Data and statistics. Web.

Mankiw, G. (2011). Principles of economics. USA: Cengage Learning.

The World Bank. (2014). Data – real interest rate %. Web.