Fiscal Policy and Foreign Trade

Fiscal Policy and Foreign Trade The a first world economy's macroeconomic objectives are many, but in this most recent global recession there are a few that would help to guarantee fiscal stability and begin to restart the economic growth process. Since these objectives represent the most up-to-date examination of U.S. fiscal policy, at least domestically, they are also the most pertinent to the U.S.'s economic survival. Foreign trade and exchange has always been a major economic boon to the U.S.

And this current recession has given much insight into the economic advantages of foreign trade and currency valuation. The U.S. has many tools at its disposal currently to help regulate its fiscal course. The Federal Reserve, an institution whose role it is to help set fiscal policy and regulate the economy, has two main goals. Other nations have central banks as well as central commercial banks that help to set interest rates and sell bonds.

The goals of the Federal Reserve are similar to those of central banks around the globe; to create maximum employment and to achieve price stability, help it to lead the way economically for the U.S. And its interests. The dual mandate of the Fed has created a situation where inflation and money supply are balanced against interest rates. Historically, as rates are lowered, inflation typically occurs.

The opposite is true when rates are raised to help stem the flow of liquidity in the market through control of the money supply (Stafford, 2010). Fiscal stability is gained through a balancing of these accounts. This is to say that a certain amount of inflation is to be expected in the economy, and interest rates are used to both encourage and discourage lending by banks. In this recession, the banks have had access to money from the Fed at very low interest rates (Stafford, 2010).

The Fed has also had the opportunity to print money and sell bonds to help both monetize their debts and encourage investment in the U.S. itself both domestically and internationally. Currently the money supply is rather large, and after the second round of quantitative easing, taking place in November, the Fed has monetized massive amounts of debt. Once this money makes it into the market, inflation will likely occur because of the oversupply of money.

In hopes of stemming the tide of inflation, the Fed Chairman, Ben Bernanke, has stated that he will raise interest rates to keep the velocity of money relatively low and to help take liquidity out of the market. There is much speculation as to whether or not this action will have enough impact to offset or balance the quantitative easing that has recently occurred or not. If it is not powerful enough to balance it, inflation could take off. Inflationary cycles occur when currencies devalue and prices skyrocket.

This is unhealthy if it is not closely regulated because it creates a crisis for the average workers who may no longer be able to afford the basic necessities (Stafford, 2010). One of the main goals of this quantitative easing has been to create employment through fiscal stimulus. This means that the Fed, through pumping hundreds of billions of dollars into the economy, is hoping that people will have access to this money and begin to spend and consume.

This consumption, it has been hoped, will lead to more economic activity and help drive jobs creation. So far, this jobs creation has been very stagnant. Without jobs there is no real hope of any sustainable economic recovery (Colciago, et. al., 2008). There are, of course, other tools the U.S. government can use to influence employment, like automatic stabilizers (Andres and Domenech, 2006). These help to encourage people to find jobs as well as help those without jobs qualify to receive unemployment benefits.

This has the effect of helping to prop up the U.S. economy in times of recession where the unemployment rate is temporarily rather high, at least in theory. Two other ways of combating inflation are through wage and price controls. Wage controls, or setting a minimum wage helps to control the amount of money that people have to spend (Andres and Domenech, 2006). It also puts massive restrictions on businesses on how much they have to pay people at a minimum.

The former is good for workers because it guarantees they will be paid a decent and livable (hopefully) wage. This helps to create economic stability within the market in terms of consumers and their consistency that they will have enough money to pay their mortgages and other financial agreements and derivatives that make up much of the economy (Colciago, et. al., 2008).

Setting price controls is a bit trickier, and has to be handled with care due to the fact that if inflation really kicks in and price controls become necessary, it may actually cause more panic than was in existence before this action. At least with price controls, a government can help keep certain items at prices that are reasonable if inflation does take over. This helps to remove the inflationary constraint (Andersen, 2007). As far as U.S.

trade policies go, there are also many tools at the U.S.'s disposal. One of them is currency valuation. If the U.S. Dollar remains strong, demand for its exports shirks, while buying power increases. This is great for the U.S. If it is looking to pay off trade debts, but as far as GDP growth, it does not help the situation. If the U.S. Dollar is weak, encouraging other countries with stronger currencies to buy and consume more U.S.

products, the U.S.'s GDP has the potential to grow since other nations are buying its products. A rise in exports also typically helps to reduce the trade deficit with other countries. If there is any severe action one way or another, the economic activity of the nation could be in jeopardy (Andersen, 2007). This means that a balanced Dollar, relative to other currencies and the trade deficits and surpluses possessed by the U.S. is in the U.S.'s best fiscal policy interest.

The U.S.'s own currency valuation, a product of the values of a basket of other world currencies, is only half of the foreign trade picture. As the U.S. Dollar fluctuates in value it is also measured against the currencies of the countries it is doing business with. Some of these countries, like the U.S., have a free-floating currency. Others, like China, do not. This presents a problem to countries like the U.S.

because China's own valuation of its currency greatly impacts the rate at which foreign trade occurs (Dolls, et. al., 2009). This is to say that as China artificially devalues its own currency, it creates more trade and economic interest abroad for Chinese products and trade. This, however, does not help the U.S.'s trade situation because it takes away from the business and trade that U.S. businesses and companies could be doing overseas.

Essentially, this action by China has had the effect of a foreign trade bidding war, where U.S. And Chinese interests are caught up in a free floating vs. artificially devalued currency war (Stephen, 2010). This would be very negative for the world economy and could lead to other measures that would hurt each economy as well as those of the rest of the global macro economy.

The Chinese central bank has also taken austerity measures that will likely positively impact its economy and trade status in the middle to longer terms (Kim and Roubini, 2008). Recently it has raised the central bank's reserve requirements, taking liquidity out of the market and helping to cool down the inflation that was beginning to occur there (Stephen, 2010). In doing so, it helps to regulate both the velocity of money as well as the money supply (Andersen, 2007).

This has the effect of limiting growth within China and helping to sustain current currency valuations. This is good for the economy because the threat of inflation in the middle to longer terms is lowered and consumers have more confidence that this inflationary cycle will not damage the economy. This also has the effect of creating more confidence in the Chinese markets overseas, helping to boost its trade and currency status.

This stability is hugely attractive to countries looking to invest in Chinese bonds as well, and helps to single out countries like the U.S. As less fiscally sound. In a globalized economy, which is beginning to emerge as the recession has affected all major nations and economies, the stability of other nations and economies affects everyone else's economic stability (Dolls, et. al., 2009). This fact, though rather simple in argument, bears a complexity that is mind-boggling. Just as the European Debt Crisis has affected U.S.

And Chinese markets, these markets have affected Europe. Because of the international mobility and demand for goods from other economies, the fiscal policies of one nation tend to bleed over to others. In this way, the globalized economies can be said to be highly interdependent and interrelated (Kim and Roubini, 2008). Decisions and policy changes have implications all around the globe, not just in the nation that makes these changes.

Improving a nation's current account, which is a product of a depreciating dollar where investors move their money to foreign currencies and trade products, also helps to boost the legitimacy and perceived strength of an economy. In Canada, this has the effect of depreciating the currency and boosting aggregate demand, which also helps to boost the country's GDP (Beetsma, Giuliodori, and Klaasen, 2006). This is a positive development within the economic functions of a country like Canada, whose currency has much influence on its trade deficit.

It can be seen that economic and fiscal policy within the borders of one country often affects others around the world. There are many different fiscal policy tools and methods of manipulating action.