Economics Coursework paper on Fiscal Policy and the American Economy

Fiscal Policy and the American Economy

Introduction

In the past five years, the American economy has experienced significant change as it emerged from one of the worst financial crises in history. The housing market was one of the areas where it was severely affected with house prices dipping so low that real estate companies could not recoup their investments and banks could not sell the houses they repossessed and were unable to recover their money leading to majority of them shutting down. The government initiated a recovery program that saw some areas develop and the interest rates, inflation and unemployment rates have significantly changed in the past years due to the government policy in place.

Discussion

The unemployment rate has in the past five years reduced significantly from its peak at sixty percent to less than thirteen percent recorded in the past year (Larsen, 2014). The cause of this has been the lack of individuals focusing on full time employment and instead opting to look for alternatives in self- employment. Full time employment is therefore no longer viewed as an attractive option for most people due to a lack of confidence in the economy’s growth and stability.

            The interest rate is at less than one percent, which is extremely low and the trend does not show any signs of changing. This is due to the Federal government’s attempt to reduce the cost of ownership as it purchased mortgage backed bonds that injected cash into the failing house industry. This would make homeowners receive the cash directly as opposed to the severely criticized bailouts that had been attempted in the past in the banking sector. It was also concluded by the government that it was best for interest rates to remain at less than one percent  to increase activity at the stock market by making investment in treasury bills and bonds unappealing (Economist, 2013).

The inflation rate has been at five percent in the past five years, which is relatively low. This is due to the lack of purchasing power among the American public, and the continued skepticism over the recovery of the economy (Sivy, 2013). The fiscal policy towards increased social benefits also resulted in the stability of prices which was necessary for the economy to recover.

It is possible for the fiscal policy to be used to stimulate growth by having it spent on items that generate spending, such as welfare benefits that increase spending at the lower levels of the economy and thus compensate for reduced spending by middle and high income earners. The redistribution of income would thus stimulate growth as high income earners being majority producers, would benefit from the increased demand for goods and services.

The fiscal policy can also be a determinant of the unemployment rate as higher benefits lead to less motivation to find employment, which in turn would lead to a reduction in the employment rate. The purpose of seeking employment is simply to earn an income for most people. If the government provides compensation for unemployment that is sufficiently high then less people will be inclined to seek employment due to a guarantee of sustenance. Higher tax rates on the alternative make it unattractive for an individual to seek employment, as they cannot afford to maintain themselves at low income levels. The gross domestic product of the country could thus be increased by a higher tax rate, as there is less incentive to remain unemployed. The fiscal policy can therefore be used as a tool to determine the production levels of the country as it affects the incentives of citizens to work and by increasing or decreasing taxes or benefits one can affect the domestic output (Mceachern, 2012).

The inflation rate is also affected by the fiscal policy selected and a policy that has high tax rates would lead to an increase in the inflation rate, as businesses would increase the cost of goods and services in order to realize the same level of profits that were recorded when tax rates were low. The provision of social benefits would have the opposite effect, as individuals would feel that the government’s subsidies could compensate for the loss of potential profits that come with charging low prices. The fiscal policy also influences the interest rates as a high tax rate would result in the government borrowing less in terms of bonds and securities and this would bring down the interest rate while a policy that encourages expenditure beyond the government’s budget leads to a deficit which it would meet by borrowing and thus raise interests rates (Mankiw, 2012).

Conclusion

The unemployment rate, inflation rate and interest in the USA have remained low in the past five years due to several reasons including the lack of purchasing power of American citizens, a lack of confidence in economic growth and government policy towards lower interest rates in order to spurn activity in the housing market. The unemployment rate however has not been low due to job creation but due to individuals seeking income generating activities in alternate fields as opposed to the traditional platforms of employment. As new policies are made there can be room for growth as the government adjusts its fiscal policy to incentivize citizens to work through higher taxes.   

References

Larsen, R. (2014). America’s beleaguered middle class. Finanical Sense. Retrieved February 28, 2014. from http://www.financialsense.com/contributors/richard-larsen/america-s-beleaguered-middle-class

Mankiw, M. (2012). Essentials of economics. Ohio: Cengage

Mceachern, W. (2012). Economics: A contemporary introduction. Ohio: Cengage.

Sivy, M. (2013). If there’s no inflation, why are prices up so much? Time. Retrieved February 28, 2014 from http://business.time.com/2013/03/12/if-theres-no-inflation-why-are-prices-up-so-much/

The Economist. (2013). A world of cheap money. The Economist. Retrieved February 28, 2014. From http://www.economist.com/news/briefing/21575773-central-banks-have-cushioned-developed-worlds-economy-difficult-period-they-have-yet