Economics concepts and applications

¶ … economic data that has been released in 2005 are somewhat contradictory, but the general impression is that the U.S. economy is managing a strong and sustainable growth. Indeed, the report published on January, 18th 2005 showed investments in U.S. assets of around $81 billion for November 2004, more than enough to finance and fund the current account deficit of $60 billion.

In terms of weaknesses, we need to mention the enormous trade deficit and budgetary deficit that the U.S. is currently encountering. These deficits have diminished confidence in the dollar, as its strong descent over 2004 has shown.

As any measure in time of economic growth and growing demand, the officials should now be concerned on policies meant to stabilize and prevent any inflationary factors. One such policy is increasing the interest rates and the Federal Reserve has already taken specific measures in this sense, increasing the rates to 2.25 and giving consistent signals that this trend will continue over the next period of time. In order to tackle the budgetary deficit, a reduction of governmental spending on different auxiliary projects is also necessary, as President Bush has already made clear he will do

2. As I have mentioned, the two most urgent and stringent issues for the American economy are the high current account and budgetary deficits. In order to tackle the former in the short run, a weak dollar is preferred so as to encourage the American exporters, who will thus benefit from lower production costs and comparatively larger export revenues.

The budgetary deficit is to be tackled by a better management of the government spending projects. It is hard to reduce defense spending given the current international situation and the threats present, but there are secondary and auxiliary programs that can be froze and tackled with at a time when the budget actually permits it.

3. In the case of companies, tax cuts affect things like net revenue and net profits and, as such, the main benefit given by tax cuts is the fact that it encourages private investment and private spending, both of which stimulate the economy due to an increasing demand of goods and services. The fact that the company has higher profits stimulates their further investments.

On the other hand, tax cuts are also equivalent to an attempt to minimize incentives for tax evasion. Indeed, it is assumed that, psychologically, tax evasion appears in conditions where the return compensates the risk implied by committing an illegality. If the return is not that high, then the incentive is diminished.

The main cost is related to the budgetary deficit I have previously mentioned. The main source of income for the government budget is represented by taxes. In the case of tax cuts, it is obvious that this is decreased and that projects benefiting from governmental spending will have to be frozen.

4. The long-term interest rates, as is the case for mortgage rates, adjust themselves slower to the changes produced on the market and to the measures implemented by the Federal Reserve. Additionally, monetary policy is generally associated with short-term financial instruments and the Federal Reserve monetary policies influence these first.