Federal Reserve and Government

American Recovery and Reinvestment Act In the wake of the 2008 market crash and the ensuing recession, the U.S. government developed a plan to shore up the economy in the face of dwindling economic activity. That plan combined federal stimulus with tax breaks to help fill the gap created by cuts in consumer spending.

The steps taken by the government were meant to create a short-term solution -- but the controversy surrounding the steps was similar to that of a doctor treating only the symptoms of a disease by placing a temporary bandage over an obviously infected wound: it did nothing to address the symptoms directly. Part of that reason was that those in charge of addressing the issue were not situated to address the actual causes of the problem.

This paper will examine the steps taken by the government via the American Recovery and Reinvestment Act of 2009 and how it affected GDP and other aspects of the economy. The Congressional Budget Office (CBO) expected the American Recovery and Reinvestment Act (ARRA) of 2009 to have a positive effect on both employment in the U.S. and GDP. The CBO anticipated a growth in GDP as a result of the stimulus in the realm of 1.4% to 3.8% by year's end, with a tapering effect in growth over the next 5 years (Young, Sobel, 2013).

The CBO also expected economic output to increase and unemployment numbers to drop as a result of ARRA -- at least in the short-term. The longer-term side-ffect of the stimulus would be that by 2020, a net decrease of up to 0.3% to baseline would be the result (Young, Sobel, 2013). Spending allocations approved by Congress, moreover, set aside $70 billion which was to be used to block more than 20 million American taxpayers from avoiding the alternative minimum tax the year of ARRA's implementation.

However, because the allocation was not assessed according to inflation, the funds did not perform the way they were originally intended, and a separate bracket of people were taxed, outside the original target. Using the model of aggregate demand-aggregate supply, price level and output via the damand/supply ratio, based on Keynesian economics, the CBO based its projections -- indicating how stimulus would create the desired effect by filling the gap in consumer shortfalls over the short-term.

The longer-term effect, according to the model, would be for the stimulus to taper off as consumer spending picked back up with the expected economic upturn. However, this has not occurred, and, as Krugman has noted, the stimulus was simply not big enough to cover the windfall: it only extended to about a third of the spending gap (Goldberg, Rosenthal, 2011). The impact on GDP, output and inflation caused by increase spending versus decreased taxes in the ARRA was more integrated than first glance would suppose.

Roughly half of the measures taken to address unemployment "were tax cuts" -- however, while tax cuts are said to "increase individual income," the "multiplier effect on overall output is generally thought to be slightly less than it is for government expenditures," the reason of course being that the individual has more incentive to save: the government does not (Economic Report of the President, 2014, p. 106).

Also, with the government borrowing money from the Federal Reserve to the amount of nearly $1 trillion, the effect that this has on the value of money already in circulation is that of devaluation. As the currency is devalued through printing (stimulus, quantitative easing, etc.), inflation of assets and products occurs: in various asset classes this is seen -- from housing to the stock market.

Investment, on the other hand, in business is not a guarantee -- especially as red tape surrounding necessary permits, etc., to launch a business pile up as a result of bureaucratic red tape. The problem, thus, is one that goes far deeper than filling a consumer spending gap: the problem is systemic. ARRA's failure to solve the issue is inherent in its approach.

Increased spending therefore does not directly impact the GDP or increase output because it does not actually contribute to the velocity of money: there was no "above normal growth" because there was no devastation that allowed for the setting to be able to be one that could permit regeneration (Elwell, 2013, p. 369). After a forest fire, there is re-growth.

The 2008 collapse did not actually occur as it should have: the central banks intervened to prop up the markets: the issues were not resolved; the fire did not consume all and destroy, allowing for above normal growth to take place afterwards. Instead, the stimulus simply fed the fire, which allowed it to continue to burn -- and it is still burning. Decreased taxes, however, effected a similar outcome: the $1,000 per couple tax credit in 2009 and 2010 saw a reduction of roughly $20 per week withheld from workers' pay.

Tax incentives for corporations and companies totaled $51 billion, with the largest allocation permitting companies to extend losses over five years. Thus, decreased taxes served the same role as stimulus -- money in the pockets of those looking to save -- but no impact on velocity or economic recovery overall because of the lack of "above normal growth" (Elwell, 2013, p. 369).

Two issues and risks to the economy of the increased budget deficit associated with the increased levels of government spending and decreased taxation contained in the act are: 1) a lack of funds for the major programs supported by the federal government (such as pensions), and 2) the inability to support/maintenance the current deficit's interest. To offset this latter risk, the Federal Reserve accommodates by keeping interest rates low, but this in turn impacts the market and distorts the risk associated with the assumption of credit.

With easy credit available at low rates, the ability of investors to know where to place their funds becomes more difficult: the actual condition of the market is distorted by the central bank's intervention. A free market, on the other hand, would validate and justify itself: strength would be apparent and by its fruits a good company worthy of investment would be known. The former issue of lacking funds due to decreased taxation becomes an issue that is compounded by a demographic.