The Keynesian economic theorists follow an economic model that considers three factors in macroeconomic growth. These are income distribution, savings, and investment functions. These factors are derived from the theory's determination of equilibrium in the economy as determined by the relationship between employment, prices, and gross-domestic-product (Padalkina 18). The theory suggests that the economy does not have full employment, autonomous demand-component affect rate of growth, and investment decisions are not dependent on savings. Therefore, the theory suggests that for the economy to experience growth there must be enough demand to push the economy to full employment (Padalkina 18). In addition, the economy experiences growth when there are increases in demand, increasing returns, externalities, and productivity growth.
The Keynesian economics have advocated that discretionary government measures and interventions are necessary in promoting economic growth, increase standard of living, and employment stability. The theorists believe in the use of government intervention, and the use of social policy development. This is in addition to the use of income maintenance programs improves the management of the economy, thereby leading to economic growth (Padalkina 18). The Keynesian theory believes the financial or market-based systems require government intervention and control to reduce destabilization. To carry out this task the government has to use fiscal and monetary policies to stimulate employment and domestic output to motivate economic growth (Padalkina 18).
The monetary theorists like Modigliani believe that macroeconomic growth is achievable by focusing efforts on the role of financial and money markets. These markets are believed to determine the dynamics of aggregate price level, output level and the role of monetary policy in economic fluctuation stabilization (Free 382). This theory believes that the control of money using monetary policies will determine the exchange rates, assets, and value of the economy aggregates. The monetary theorists suggest that to grow macroeconomics requires the control of the amount of money in circulation through interest rates (Free 382). Interest rates determine the cost of financing holdings and cost of holding money, and increase the value of currency as compared to other currencies. In this manner, these mechanisms determine the demand and supply of services, goods, and assets, including measures of money by financial intermediaries, firms, and households.
Monetary theorists find Keynesian economics incomplete; explain monetary policy by promoting macroeconomic stability. The theorists suggest economic growth achievable through the targeting of monetary aggregates, which is the keeping of money supply growth constant (Free 383). This is to promote long-term economic stability. This money supply in maintained by adjusting nominal interest rates to allow the central bank to influence activity level in the economy (Free 383). In addition, through management of inflationary expectations, to moderate and lower inflation. Monetary theorists also believe in the minimizing of volatility in inflation and output in target levels. The monetary theorist like Taylor believe in minimizing inflation volatility on targeting rule, which are the rules built on output and inflation targets (Free 384). However, monetary theorists like Svensson believe in the minimization nominal interest rates.
Budget deficits and trade deficits are dependent on each other. Persistent trade deficits like that seen in the U.S. reduces wealth in the hands of citizens and in the economy, causing high shortfalls in government and unemployment programs. The more the government spends on social and unemployment programs, the more financial resources become scarce (Shannon 27). This scarcity leads to a larger budget deficit, as funds are depleted assisting social support systems. Persistent budget deficit creates massive debt as savings are taken away from capital investments of the government. This in turn creates massive debts for countries that make purchases in a nation with a large and persistent budget deficit (Shannon 27). The persistent budget deficit implies that nations seeking to make purchases will not buy products, sell their holdings of accumulated currency in international foreign exchange market. The debt created by the persistent budget deficit leads to debts in the financial and money markets, causing greater trade deficits (Shannon 27). For this reasons since the U.S.A. is the primary market and whose currency is used as the international exchange in the markets, its persistent budget deficit in the last five years has led to trade deficits in other nations.
In a situations where national savings is available and offers opportunities to improve trade deficits, there are several options available for policy makers to improve the economy. The first option for policy makers is the regulating the markets to increase national savings. This is through tax reform policies that will encourage saving and investment. For the tax reform to work, the policy makers must simplify the tax code, fairer, to promote growth, savings, and job creation. This is by reducing bias to savings and investment in the tax system. A second option is reforms in national spending to reduce the budget deficit, which reduces national savings. This is because budget deficit's effects are felt in future budgets as it reduces national savings, increases interest rates, and crowding of investment. In this option, policy makers have a chance to reduce budget deficit through reduction of expansionary tax cuts and restraining spending. The third option for policy makers is making reforms to social security system. Government spending increases with increment in entitlement programs like unemployment and programs for the elderly, population age, and baby-boom generation retirement. This includes policies on making adjustments for inflation, reducing the higher real benefits for future generations, reducing indexation on benefits to wages.
Supply-side economics or tickle-down economics indicates that a reduction of taxes should stimulate the economy by increasing spending by consumers. The theory suggests that in due time the reduction of taxes will lead to a boost of economic growth that generates a bigger tax base and make up for revenue lost from cuts in taxes (Baumol and Stuart 227).
However, besides best efforts supply-side economics propose the reduction and cutting of some taxes to boost the economy (Baumol and Stuart 227). Tax cuts imply an increment of government spending on entitlement programs like unemployment and programs for the elderly, population age, and baby-boom generation retirement. Tax cuts create inequality in the economy and increases the government's budget deficit from a reduction of income. This is because tax cuts lead the government to use budget surplus, reduce national savings, which in turn leads to larger budget deficits (Baumol and Stuart 227). Supply-side economics tax cuts are directed towards the reduction and cutting of huge taxes for the rich since they have the resources to invest. They also propose the reduction of government regulation on business to increase productivity and investment as a means to increase economic growth (Baumol and Stuart 227). Theorists of this economic model believe tax cuts and investments will lead to a trickledown effect of money to the working class by creating more jobs and increasing income. In turn, increment in income and jobs will reduce government spending on social welfare programs (Baumol and Stuart 227). However, the supply-side economics insistence on fewer government regulations and interventions imply that income gained from tax cuts can be invested in other parts of the world economy apart from the domestic economy. For the theory to work, income from tax cuts must be invested in the local economy for the tickle down effect to work.
The current U.S. national economic policy is to raise national savings by a reduction in the federal budget deficit, reduction of trade deficit, inflation, participating in the right free markets in national industry policies, regulations, and antipoverty efforts (Shannon 28). The reduction of the trade deficit will lead to an increase in investments in many sectors of the economy especially in industry and manufacturing. This is especially seen in the recent increment of manufacturing in the nation, which is causing a slow economic recovery, as more than…