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Economics: The State of the U.S. Economy
Cousin Edgar, a global investor, is seeking to capitalize on the thriving gasoline industry and the rising world demand for oil by purchasing several gas stations in the U.S. market. Inspiring his interest is the high price of gasoline, which he reckons will rise even higher in the near future, thanks to the urbanization and industrialization currently being witnessed in the developing economies of Asia. Furthermore, the turmoil facing some of the world's largest oil- producers has spurred fears of supply disruptions, and, consequently, opened up growth avenues for smaller producers such as the U.S.
Cousin Edgar reckons that he will need financial reinforcement, which will most likely not be much of a problem, given that the ongoing recovery efforts have managed to stimulate loan growth to reasonable levels that are essentially near the pre-recession index. However, economic weakness still remains evident, and there are concerns that the economy may never fully recover from the effects of the 2008 depression, or that it may do so at a pace that is slower than would be expected. These macroeconomic concerns have led experts to question the suitability of the U.S. economy as a business environment, at least for now. To this end, one may wonder - is cousin Edgar's timing really right? This report provides answers to this question by examining the trends in eight crucial macroeconomic indicators; GDP growth, demographics, international trade, interest rates, monetary policy, unemployment level, fiscal policy, and business cycle.
2 Relevant Economic Principles: Determinants of Demand and Supply
The 2008 recession has been termed "the most severe economic contraction since the 1930s" (Elwell, 2013, p. 1). Economic activity, as Elwell (2013) points out, was moderate over the first two quarters of 2008, but the financial crisis came in, overtook the already weakening economy, and accelerated the decline. Recovery efforts kicked off in mid-2009. Since then, there has been moderate increase in employment, with the stock market showing signs of recovery, and real GDP rising, although at an uneven pace.
On the other hand, the Federal Reserve, in the wake of the recovery efforts, unveiled three quantitative easing efforts that collectively increased money supply, causing inflation and shrinking the dollar's buying power - in an overturn of events that has seen it lose significant ground against the world's majors. Subsequently, international trade has been affected as imports have become more expensive. The national debt has shot up, from $9.2 trillion in 2008 to $14.5 trillion in 2013. Experts expect the national debt to reach $20 trillion, almost 140% of current GDP, by the year 2020.
2.2 Real GDP Growth Rate
On average, the economy grew by 5.6% over the last decade of the twentieth century. The economic slowdown was, however, quite evident even before the 2008 bursting of the housing bubble. The GDP growth rate fell from 6.52% to 5.12% between 2005 and 2006, and dropped even further to 4.42% in the last quarter of 2007 (Multpl.com, 2014a). As depicted in figure 1, the decline of economic activity bottomed in the last quarter of 2008, hitting an all-time low of -0.98%, with real GDP contracting by approximately $680 billion or 5.4% (Elwell, 2013). The output gap at this point widened to a significant 8.1%, the largest measure since World War II.
The launch of the Economic stimulus Program in March 2009 marked the beginning of economic recovery. Its effect had, however, hardly been felt by the end of the year, and the GDP recorded an anemic growth of 0.12% (Multpl.com, 2014a). Since then, GDP has been on an upward trend, with a small drop in 2011 that was occasioned by the high foreclosures that had kept the housing market from recovering fully (Elwell, 2013). The growth rate averaged a healthy 4% between December 2010 and March 2014. Furthermore, the output gap has reduced significantly since 2009, and was reported at 4.6% in the first quarter of 2014 (Multpl.com, 2014a).
Table 1: GDP Growth Rate from December 2005 to March 2014
% GDP Growth
(Source: Multpl.com, 2014a)
Figure 1: Percentage GDP Growth Rate (2005 -2014)
2.3 Fiscal Policy Actions
In 2008, Congress passed the Economic Stimulus Act, "a $120 billion package that provided tax rebates to households and accelerated depreciation rules for business" (Elwell, 2013, p. 3). Later on in 2009, the Obama administration adopted the American Recovery and Reinstatement Act, which incorporated a $787 billion bouquet with $501 billion of spending increases (26.2% rise from government spending in 2008), and $286 billion of tax cuts (Elwell, 2013). These fiscal actions are reported to have stimulated the economy to a significant extent, accounting for more than half of GDP growth between 2009 and 2010 (Elwell, 2013).
With regard to extraordinary measures, President Bush assented to the Emergency Economic stabilization Act of 2008, bringing to life the TARP (Troubled Asset Relief Program), which "authorized the treasury to use up to $700 billion to directly bolster the capital position of banks or to remove troubled assets from bank balance sheets" (Elwell, 2013, p. 3). As a result of the increased spending, the federal budget deficit rose to approximately 12.5% of GDP in 2010, with the federal debt shooting up from $9.01 trillion in 2007 to $14.5 trillion in 2013 (Scully, 2009, p. 6).
Of significance, however, is the contraction of spending by the government -- at both the local and state levels. State and local governments reduced their spending by 1.8% in 2010, 3.4% in 2011, and 1.4% in 2012, subtracting 0.2, 0.4, and 0.2 percentage points from GDP respectively (Elwell, 2013). However, the federal government moved in, in mid-2013, and tightened its fiscal policy following the expiry of the "2 percentage point cut in payroll taxes and of tax rates cuts for incomes above certain thresholds" (Elwell, 2013, p. 20).
2.4 Monetary Policy Actions
In 2009, Fed injected additional funds into the financial system with the aim of inducing confidence among lenders, and getting them to devise new lending programs (Elwell, 2013). With this, Fed's balance sheet almost doubled, reaching approximately $2 trilion by 2010 (Scully, 2009). To keep loan demand from falling, Fed purchased "$300 billion of treasury securities, $200 billion of agency debt (later revised to $175 billion), and $1.25 trillion of mortgage-backed securities" by injecting the funds generated from the TARP (Elwell, 2013, p. 3). By 2010, the inter-bank lending rate, as Elwell (2013) points out, had fallen to almost zero. In September, 2013, Fed executed the 3rd round of quantitative easing, purchasing in an open-ended fashion additional "mortgage-backed securities at a pace of $40 billion per month" (Elwell, 2013, p. 23). With this, Fed plans to continually inject funds into the economy until labor markets improve. Moreover, in its 'forward guidance' report released in March 2013, Fed announced its plan to maintain the interest rates for federal funds at exceptionally low levels through 2015 (Elwell, 2013).
2.5 Interest Rates
Interest rates for short-term loans have fallen to near zero, whereas those of long-term loans have been maintained at extraordinarily low levels since 2009 (Board of Governors of the Federal Reserve System, 2014). The collective interest rate averaged 4.8% between 2000 and 2007, but fell considerably between 2010 and June 2014, to average at 2.7% (Table 2)
Table 2: Treasury Interest Rates (Average) between 2005 and 2014
(Source: Multpl.com, 2014b).
2.6 Unemployment Level
A persistently high rate of unemployment has negative consequences on citizens' well-being and also impacts negatively on the federal budget (Levine, 2013). The unemployment rate hit an all-time high of 9.7% in December 2009, just as the economy was beginning to emerge from the 2008 recession (Levine, 2013; Multpl.com, 2014c). As Table 3 indicates, the rate has slowly declined since then, dropping below 8% at the beginning of 2013 for the first time since the recession (Levine, 2013; Multpl.com, 2014c). Despite the declining trend, "the unemployment rate remains high by historical standards" (Levine, 2013). See figure 3.
Of significance is that the unemployment rate took a considerably long period of time, three and a half years to be precise, to fall by one full percentage point after the 2008 recession (Levine 2013). In previous recessions, the economy took no more than 8 months to gain, in terms of unemployment rate, by one percentage point (Levine, 2013). This has been one of the crucial indicators that the economy is recovering at a pace slower than normal (Levine, 2013).
The reduction in unemployment levels has, in line with Okun's law, been attributed to the reducing size of the output gap. With every increase in actual output, the economy moves closer to achieving full employment in terms of labor supply and potential productivity (Levine, 2013). The congressional Budget Office, using the framework…[continue]
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