Fiscal and Monetary Policy and Economic Fluctuations

¶ … economic situation in the United States is favorable compared with five years ago. Five years ago, it was late 2009 and in the depths of the Great Recession, so performing better than those levels is no great achievement. But as a point of comparison, all metrics are better today. The annualized rate of GDP increase in the third quarter of 2014 was 3.9%, down from 4.6% in the second quarter, according to the Bureau of Economic Analysis (2014).

In 2009, the Q3 GDP was 1.7%, which is a low number, but at the time represented positive growth following three straight quarters of declines. Thus, technically, Q3 2009 was when we emerged from recession (Treasury, 2012). GDP growth in the interim has been uneven, but the past couple of quarters indicate healthy, manageable growth that should not lead to runaway inflation. Unemployment, which is a lagging indicator, is 5.8% as of October 2014, which is the lowest level since July 2008. In October 2009, it was 10.0%, which was the peak level.

This peak occurred as a result of the recession, as again unemployment lags GDP. The levels in 2007, before the recession, were in the 4.somethings, so the current level is still higher than pre-recession levels. It has been declining ever since October 2009, but unemployment is still higher than it should be in a healthy economy. Inflation has remained low during this period. The Bureau of Labor Statistics tracks inflation. In October 2014, it was 0.0%, with an annual increase of 1.7%.

This is below the target inflation rate of the Federal Reserve, with is 2% (BOG FRS, 2013). Thus, despite the strong economic growth in recent quarters, inflation is not following suit, but is in fact rather muted. Part of the reason inflation flatlined in October was a decline in energy prices, as the CPI minus food and energy saw 0.2% increase in the month (BLS, 2014). Five years ago, this was 0.1% for the month, and a deflationary rate of -0.18% for the year.

This deflation was the result of the recession, and was the culmination of a deflationary trend that began in March 2009. Interest rates have been near zero the entire time. The discount rate is current 0.75% and five years ago it was 0.5%. These rates are quite low historically and indicate stimulatory monetary policy. They were used in 2009 to help spur business investment by lowering the cost of capital, and the same logic applies today. 2.

The story of the changes in the last five years is the story of the Great Recession and the recovery from it. Since 2009, the GDP has increased and it is growing at a healthy rate at present. The GDP was just coming back to growth in the fall of 2009 after a long period of decline. In the five years since, the GDP has mostly been growing, a sign of recovery.

While the recovery has been uneven, and maybe could be considered to be weak, recent quarters have shown that the economy is finally growing at a stable, healthy rate. The even growth might reflect in the odd combination of fiscal and monetary policy responses to the recession. The unemployment rate hit its apex (or nadir, more realistically) in October 2009 as the result of the Great Recession. The next five years have seen a slow but steady decline in the unemployment rate, to the current level.

There is no reason to believe that the current level is anything other than another stopping point on the way back to a natural equilibrium, which would be in the 4-range. There are some skeptics who take the view that there are more people who have voluntarily exited the job market (Matthews, 2012), and that is why the unemployment rate has been improving, but these individuals would not be sufficient to buck the overall trend downwards from 10% to 5.8%. Interest rates have remained low in order to stimulate the economy further.

There are two reasons for this. The first is that there is basically no meaningful fiscal policy forthcoming, so the Fed has to do all of the work on this. The second is that the economy is still below the pre-recession trend line. In other words, while the economy is humming along nicely, it still has not caught up to where it would be without the recession, something that is also borne out in the unemployment numbers.

It is, however, getting close to that trendline, if you look at the graph on Fred (2014). 3. There are two major approaches to economic policy -- monetary policy and fiscal policy. Monetary policy reflects the actions of the central bank to manage the money supply in the economy. Fiscal policy is government taxation, spending and programs. To encourage people to spend money, there are options in both. In terms of monetary policy, encouraging consumer spending is only going to happen through indirect means.

For example, the Fed could set the discount rate low, which lowers the cost of capital for the banks. In a competitive environment, the banks should then lower the rates that they charge to consumers in response. With lower interest rates, consumers should be more willing to spend on large purchases like cars and houses, which are keys to driving consumer spending.

This actually was not as successful in the Great Recession because banks were gun-shy about lending after all the mortgage defaults and underwater mortgages, while consumers were worried about their jobs, and thus reluctant to commit to major purchases. In terms of fiscal policy, there was TARP and the stimulus. The objective of stimulus is to provide jobs and put cash into the hands of the middle class. So infrastructure works are a popular form of fiscal policy during recessions.

In the short-run, infrastructure works help lower the unemployment rate and inject money into the economy. In the long-run, the nation's economy benefits from the new infrastructure, and there is benefit also in keeping people employed, because long-term unemployment tends to lower a worker's future potential dramatically, which also has a negative effect on the economy. 4. The discount rate strategy directly impacts interest rates, bringing them down very far.

If this is done in recession, the inflation rate should not be affected much, but if done outside of a recession it will be an inflationary policy. In any scenario, the expected increase in lending will lower the unemployment rate. Not only will it prop up the automotive industry,.