US Economics Term Paper

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US Economy

Hypothetical Economic Scenarios:

response to five proposed fluctuations in the U.S. Economy,

As viewed through a Keynesian Lens

Overview of Keynesian Theory and the Current U.S. Economic Situation:

Even Keynes' critics call him the greatest and most influential economist of the 20th century. For this reason, he is known as 'the father of modern economics.'" ("Keynesian Economics, an Overview," The Great Depression Homepage, 2003) Keynes has been credited for the generally high employment that characterized the United States in the 20th century until the 1970's, before the theories of the conservative Chicago economist Milton Friedman began to dominate academic and political circles of thought. (Yergin & Stainslaw, 1998) When the United States was attacked by terrorists on September 11, 2001, Americans were urged to 'spend, spend, spend' their way out of the looming economic crisis that was feared by politicians and economists alike. For a time, shopping at the mall and patriotism became virtually synonymous. A long time advocate of spending a nation out of employment, John Maynard Keynes would no doubt have approved of this element, though perhaps this element alone, of the Bush administration's advice to the U.S. consumer. (Yergin & Stainslaw, 1998)

Keynes stated that "in a normal economy," there is a high level of employment, and everyone is spending salaries as usual. This means there is a circular flow of money in the economy. Individual spending becomes part of total earnings. Total earnings become part of the total spending, generating profits. When something happens to shake consumer confidence in the economy, consumers begin to save their money. Because consumer spending is part of other consumer's earnings, consumer's decisions to hoard money cause retailers to spend less and to lay off employees. Responding to these difficult times, "other consumers resort to hoarding money as well. " ("Keynesian Economics, an Overview," The Great Depression Homepage, 2003)

One such "difficult" event to shake consumer confidence, one might contend, was September 11th. However, even before then, the economy had begun to contract, as a result of the bottoming out of the inflated stock market technology and boom and bust of the 1990's. The Federal Reserve resorted to slashing interest rates to encourage consumers to spend more and to save less. Keynes advocated at the time of the Great Depression that individuals should spend more. The government could encourage this by extending the money supply. But f this increase in liquidity did not cause things to improve, however, Keynes stated that the government itself should create jobs by spending money, even if this required the government to spend itself temporarily into a deficit.

Hypothetical Occurrence 1#: Stock market prices rise sharply

Thus if stock market prices rose sharply, this would be an indication, according to Keynes, that the economy was looking up and that consumers were willing to spend more. More money funneled into the economy generates more investments in existing and developing businesses. The Gross Domestic Product or GDP will expand. The rate of inflation may rise as more money is flushed into the actual economy of transactions and people's demands for goods and services increases. Unemployment should decrease because businesses are expanding and investing more. The government does not need to resort to extending the money supply or increased deficit spending as the economy is already recovering.

There is one caveat to this rosy scenario, however. Because individuals have grown so jaded about the 1990's stock market boom, such an increase might cause investors to still be wary about sinking their diminished retirement nests and funds set aside for children's future college needs into the market again. They also, in a more general sense, might be less likely to spend as wildly and as widely as before, further limiting the potential of this singular development to generate as much economic growth as the scenario might cause one to hope. This increase in the stock market might be seen as a temporary bubble.

Consider why people start hoarding in the first place. A consumer loss of confidence in the economy may be "triggered by a visible event like a stock market crash." Or it may be triggered by "a natural disaster, such as a drought, earthquake or hurricane." Or a terrorist attack. In this case, both 'triggers' were present to contract economic growth.

Keynesian Economics, an Overview," The Great Depression Homepage, 2003) The memory of the stock market trigger might be too fresh.

Hypothetical Occurrence 2#: The conference board's index of consumer confidence falls for the fifth straight month

In most basic Keynesian terms, this should raise a red flag of alarm. This means that many individuals have a low level of confidence in the economy. Consumers will likely be spending less, as the consumer confidence index measures not only what consumers are doing now, but also their projected future economy goals. This index is a measure of perceptions, and it indicates that consumer perceptions are that things are getting worse rather than better and that this is a persistent psychological economic pattern.

As a result, this means that the GDP is likely to contract, if it is not doing so already. Inflation is unlikely to rise because people will likely be spending less and hoarding their money rather than using it to drive the economic expansion the government futility hoped for. Unemployment is also likely to increase.

In this scenario, the Federal Reserve might cut interest rates again, but given that this has already been done repeatedly, it might seem that the government is resorting to this as a way of stopping a hole in a still-sinking economic ship. It is interesting to note, incidentally, that the fact that the Federal Reserve had tightened the money supply too much, compelling people to hang on to their disappearing dollars, is cited by many anti-Keynesians critics of activist government believe as to how the Great Depression really started. ("Keynesian Economics, an Overview," The Great Depression Homepage, 2003)

Hypothetical Occurrence 3#: The rate of capacity utilization rises

The rate of capacity utilization refers to the economy's ability to utilize its capacity to produce goods in services. In other words, every economy has a finite capacity to produce a certain number of goods and services at any given time. The United States' ability to do so is larger than, for instance, a Third World Nation's. However, even the U.S. does not exercise the maximum rate of its capacity of utilization at all times. In other words, not all factories are producing as much as they could, nor is there full employment. It is worth noting that this type of expansion did occur almost to the U.S.'s maximum capacity during the heady boom of the 1990's.

The rate of capacity utilization, or the amount of goods produced, means that the Gross Domestic Product of the United States is likely to increase, as more of the economic capacity of the nation is being utilized. The economy is expanding, and unemployment will decrease, as more workers are likely to be employed to physically utilize the factories, etc. that have caused the rate of capacity utilization to rise. As more goods are funneled into the economy, more money is generated and inflation is likely to rise as consumers have more dollars to 'bid' for goods and services. This is provided that consumers feel confident enough to spend rather than save, however, given the recent memory of the events of the 1990's boom and bust.

Hypothetical Occurrence 4#: The government institutes a 10% investment tax credit retroactive to the start of the year

Tax cuts are often seen as anti-Keynesian measures because they take money away from the federal government. Rather than having more funds to funnel into the economy to create jobs, now the federal government has less. The theory behind tax credits for investments is that they should encourage businesses and individuals to take advantage of the opportunity to invest more of the money they have in savings in the stock market and other business ventures, hopefully generating jobs, expanding the Gross Domestic Product, and increasing the rate of growth and thus increasing the rate of employment as opposed to unemployment. Inflation may go up as well as there is more money in the economy to compete for products, and a greater demand for goods.

A retroactive tax cut means that individuals who invested money already over the course of the last year, as reported on their already submitted tax forms, will now get a refund. Hopefully, this should give people more money to invest in the economy and encourage them to invest for yet another year. However, it is also possible that consumer confidence, as it has been falling, will cause investors to be wary of investing too much in the shaky economy, and simply take their tax credit and run, or at least, hold onto the money. If this is the case, the federal government will have less money to create jobs with, causing unemployment to rise. Inflation will not rise,…[continue]

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