Forcasting the Years Ahead Pose Term Paper

Excerpt from Term Paper :

The forecast provided by Allen Sinai gave the reader a somewhat accurate analysis of the macroeconomic phenomenon. However, there are also a few problems. Sinai estimates a 0.4% increase in 2005 for the consumer price index, which is not actually correct, but it's not to far from reality either. Given the increase of the interest rate, people will probably feel not so comfortable in buying as much as during the previous years, so a slight decrease can be expected. After all, January is known as a slow month. 0.4% means about 4% a year, which is much more than the economy is currently able to take.

The estimated trade balance was larger than the recorded one, therefore proving the pessimism of Mr. Sinai. After all, many analysts expected worse trade deficit results than the one that were published in November 2004. It would seem that the low-value dollar policy promoted by the Federal Reserve proved more than welcome for the exporters, which did great (at least compared to previous results) in selling their products overseas.

The IMF report is the most pessimistic one of all. The report starts by stating "From an extremely strong position in the year 2000, the U.S. fiscal position has deteriorated rapidly." Tax cuts, high budgetary spending and other factors have put their mark on the U.S. budget. The current administration makes a few optimistic (yet again) assumptions concerning the deficit. The chance that each of them is to become reality is very slim. Consider only the costs of the Iraq war. The Bush administration vows to strictly contain it, which is highly unlikely, given that the budgetary expenditures implied by initiatives of this magnitude are almost impossible to predict.

The IMF report admits that the fiscal outlook depends on the growth of activity, so any above average growth in productivity in the next few years could improve the general picture. Still, the historical perspective is not that good. The 2004 deficit is almost as big as the record-setting one during the Korean War. In level terms, current deficits are unprecedented (another achievement for the administration). Optimistic forecast were also made during the 1980s period, but they failed to materialize. The only solution was to impose "painful" fiscal rules designed to reduce and eliminate the fiscal deficit.

Past experience suggest that coherent measures should be taken in order to reduce the fiscal deficit. Still, compared to the past, the present U.S. economy seems stronger, while most of the deterioration in the fiscal position is limited to the United States. On the other hand, pressures on the budget will probably increase in a progressive fashion over the following years, despite the Government's reassurances that such a thing will never happen. Additionally, problems such as the baby boom generation retirement time is likely to add to the current budgetary problems.

The IMF study identifies four key channels through which the world economy is to be affected, as a result of the U.S. fiscal expansion: the boost in activity attributable to the short-run fiscal multiplier, the reduction of private consumption or private saving on the medium-term, decreases of the work and save incentives provided by the administration and pressure on the current account position in the short-term, which creates a higher need to service U.S. debt and debt payments to the rest of the world.

The U.S. fiscal expansion should, at least at first glance, lead to an appreciation of the dollar, since foreign capital is attracted by promises of higher interest rates. In medium term, however, the exchange rate begins to depreciate, in an effort to rebalance the current account deficit and generate surpluses, necessary to cover the cost of the higher net foreign liabilities accumulated during the fiscal expansion. The huge U.S. fiscal and external deficits have long worried the international community, since they can result in international imbalances. The rapid fall of the value of the dollar and the rise in U.S. long-term interest rates is what the IMF experts expect to see, should such a thing happen.

As for the problems posed by the trade deficit and the current account deficit, it is obvious that Mr. Greenspan has done all things possible, accompanied by policy makers, to protect the interest of American exports. U.S. monetary policies have sometimes attracted furious reactions from trade partners such as the European Union or Japan. It is clear for everyone that very large budget deficits lead to inflation, which is something Mr. Greenspan, true to the Fed's price stability policy, should try to avoid. Defense and other similar sectors of the economy should not be financed as consistent as they now are, since Mr. Bush's international plans are ruining the nation's economy, which has passed a very rough period and which should not be subjected to further constraints.

The dollar was kept at a low value to promote exports. The trade balance deficit published in November was not actually so bad as many analysts would have expected: only 56.4% billion. This indicates that the dollar has fulfilled its job as an instrument in the hand of American exporters, which were able to beat the Euro, the Japanese Yen and the Chinese Renminbi, but that it also contributed to the revival of the U.S. economy, which had suffered a lot during the bear market years at the beginning of the new millennium.

Therefore, although the dollar will probably maintain its low profile for a while, I believe that its value is kept down by the Federal Reserve, and that the dollar has enough intrinsic resources to come back in force in a few months. Perhaps as this year will come to an end, we will assist to a come-back of the almighty dollar from a few years ago.

The fiscal incentives in the last period have moved shifted the AD curve to the right from AD0 to AD1. The prices and real output are also modified: the price level goes from P0 to P1, while real output rises from Y0 to Y1.

The monetary policy conducted lately by the Fed has lead to a significant depreciation of the dollar, compared to the currencies of the trading partners. The AD curve shifts to the right from AD0 to AD1. The price level rises, and so does the real output level: P0 to P1 and Y0 to Y1.

A tax cut usually results in higher interest rates and higher inflation. The Fed pursued a contractionary monetary policy, which shifted the LM curve and moved the economy to the equilibrium point. (Y*). The two graphs look pretty much the same. After all, the Fed and Government have concentrated all their efforts on obtaining a higher Aggregate Demand. Therefore, all fiscal and monetary policies are aiming in that direction.

As far as I can tell, fiscal policy influenced savings, investments and growth in the long run (which is also reflected in the long-term debt-financing characteristic to the present-day market). Aggregate demand was also favorably affected. Since government spending heavily increased lately, an increase of the Aggregate Demand is not a surprise. The crowding-out effect is presented in detail in the IMF report.

Monetary policy was also conducted with the purpose of shifting the aggregate demand to the right. The interest rates were lowered and the quantity of goods and services demanded at every price level increased.

As far as the forecast for the next year is concerned, since Chairman Greenspan promised to increase interest rates, the effect should be a shift to the left of the Aggregate Demand curve, and a lower real output rate. The result should be a steadier perspective for all the economic indicators. Consumer spending will probably continue to grow, but not as much. The savings rate should also grow in the next few months. Financial markets will probably be influenced by rising optimism, as the United States seem to be successful in the fight against terrorism. Productivity will continue to decrease, but will probably be kept at acceptable levels. Profit margins are already pushed down by competition.

As for the quarterly forecast, I expect a low-value dollar in the first quarter and the first results of the new Federal Reserve monetary policy in the following. The economy will probably continue to grow, but a slower pace. If things in Iraq and the terrorist threat do not bring any surprises, one might even see a surprising economic progress from our nation's economy. The third and fourth quarter will probably bring lower deficits and a more stable macroeconomic situation. After all, 2005 should be the year when all the efforts of the Fed shall be rewarded.

The dollar has lost a lot compared to all other major currencies, in an all-out effort to support the U.S. economy. This economy is no longer in crisis, as chairman Greenspan's report clearly shows. Despite the large dosage of optimism and the problem of huge public debt and current account deficits, the market economy should finally put its mechanisms to work and interventionist…

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