The September, 2003 supplement to the Economist, Running on One Engine contains a survey of the worlds economy, and outlines how the economic engine in America is similar to the single engine operation in a large commercial airliner. Connections are not made by the writers that an airliner operating on one engine can stay in the air for a limited amount of time, but cannot be expected to fly without problems, nor can it be expected to continue its course as if it were running on all of its multiple engines. The economists carry the metaphor to the country, and the global economy. The single engine is taxed beyond its design capacity. The overworked engine could fail, and thereby leave the airliner no other option but to plummet ground ward. In the same way, the authors say that the American economy, should it stall, could bring the entire globe's economy into a spiraling descent.
Economics is the study of numbers, trends, investment, debts, etc., that help predict how decisions taken by individuals, firms, households and governments will affect the wider population. In our current world, every monetary decision by major, global powers has an implication on the overall global economy. The decision by the American people to increasing their savings percentage or increase their debt load will affect supply and demand curves in china, Japan, and Europe. When the U.S. government also enters the economic sector, and becomes a major contributor to supply, demand, and monetary availability pressures, government policy also becomes a significant factor in charting economic trends.
The purpose of economics is to analyze an aggregate set of decisions and explain how, together, they compose the global economy. The focus of this is to provide an analysis of the global economy as of September 2003, focusing specifically on the American current-account deficits and the consequences this might have on the world economy.
The models used in the first half of our class are representative of individual behavior within the different markets that together make an economy. This perspective is a micro-economic evaluation of the overall economic activity. During the second half of the course, study focused on the overall economy and the models represent the macroeconomic consequences of corporate (group) behaviors and market activity.
The precise focus of the economic models used in the second half of the course was designed to predict and explain how the decisions regarding fiscal and monetary policy, together with the consumer choices and private sector firms affect the economy on a macro scale. By understanding how corporate (group) behaviors affect the larger economy, economists can then analyze and view the transformation from a micro model to a macro model. In any evaluation of the global economy, both a micro and a macro perspective are necessary in order to understand current conditions and draft policy recommendations.
Several models define the economic activity of a country on a macroeconomic level. The goods market, the capital market, the foreign exchange market and the money market all combine to create the ISLM, and the BOP framework which analyzes and explains the macroeconomic behavior of an economy with regards to the changes in each of the specific markets.
The goods market is an aggregate representation of how consumers are going to behave, and as such the goods market significantly affects the supply and the demand side of the economic equation from the consumer micro-economic sectors. Consumers can either save or consume, and depending on current interest rate, perception of the consumers in economic outlooks, the goods market will change significantly over time. As this market changes, it exerts pressures on other sectors. If interest rates are low enough consumers will borrow money in order to spend beyond their income level and re-pay the debt later, which in turn affects the capitol and money supply markets.
The capital market is the source of long-term funding for business and government expenditures. The capital markets, funded by securities such as bonds and shares in companies, is used to measure of the demand and supply investment moneys in the economy. The capitol market can be funded by government, or by private industry. A greater amount of money in the capital market suggests more confidence in the economy, and also represents a higher amount of debt for the country. The supply and demand of bonds is balance by the interest rate.
Affecting the money supply between countries, the foreign exchange market shows the relationship between two currencies when they are exchanged between the countries. Foreign exchange rates are affected by the relative economic strength of each country and by the supply and demand curves in each country. Foreign exchange rates can also be affected by the political relationship between participating nations.
The money market tells us how much demand there is for a short-term currency, typically used for short-term investment and spending. The interest rate defines the amount of currency demanded, while the central bank of the country determines how much currency is available in the market. When the monetary base is expanded, there is an associated decrease in demand for the currency. Therefore the interest rate will tend to drop, thus creating easier access to moneys which can in turn create riding demand.
To bring all the models together the ISLM - BOP graph presents the different balancing factors on one graph, and shows their interrelatedness. Composed of the IS curve (The Investment vs. savings balance) and the LM curve (money supply vs. money demand) and then the three functions this model provides a broad perspective of macroeconomic activity within an economy. The ISLM curves represent the internal balances within a country. The BOP curve addresses the balance of payments between countries, therefore addresses the external monetary balance of the country with its trading and economic partners.
Government policy and economic reactions
The government's fiscal and monetary policy provides stimulus from different approaches this thus affect the ISLM-BOP graphs. Fiscal policy which includes taxes, spending, and the management of the budget deficit affects the IS curve. Monetary policy which is guided by the Federal Reserve, which includes money supply, and interest rates and the resulting demand for money to fund capitol expenditures, affects the LM curve.
A nation's government taxation plays perhaps the largest single role in the flow of economic activity. Although understanding of the government's role as a taxing agent differs between administrations and form country to country, the results to government's taxation policy are evident across the model. Taxes affect organization's ability to invest in new economic activity, and taxation also affects household income.
Increasing taxes create a rising pool of moneys for the government to use as spending projects. Increased government spending is assumed by many to stimulate economic growth because government is affecting the demand on the economy. However, supply side economic policy takes a different perspective of government spending, and on the resulting economic activity. When government increases taxes, while they are able to increase spending, they also create a negative drag on the economy. They reduce the incentive for business to invest and expand because a larger amount of the profits will be deducted by government. When governments raise taxes, they also compete for the money supply by creating forces which restrict the availability of money in the marketplace. Therefore, while government spending increases, and affected positive forces in the marketplace, the negative drain on money availability, and decreased incentive tends to slow the economy. So when business taxes rise business investment will decrease and this will shift the IS curve inward. Larger government spending is designed to increase demand and which stimulates activity within the economy, but the increased demand rarely overcomes the increased drag created by higher taxes. Lower government spending is known as contraction takes away some…