Macroeconomic Policy Jan 20, 2021,

Macroeconomic Policy

Jan 20, 2021, inauguration day is a cold, overcast, and dreary day in the Nation's Capital, representative of the economic malaise which has gripped the country. With the economy hemorrhaging jobs at several hundred thousand a month, and GDP negative for three consecutive quarters, the American people are clamoring for the new administration to take action. It was only twelve short years ago that newly elected President Obama faced a similar economic downturn brought on by a financial crisis rooted in subprime mortgages. The actions of his administration focused on a Keynesian response to the crisis, replete with considerable spending in hopes of lifting economic growth through the government expenditure component of GDP. Concomitant to this approach, Federal Reserve Chairman Ben Bernanke set and continued a near zero interest rate federal funds policy to help stimulate the economy through a reflation trade.

Fast forward twelve years, and as the newly elected President, a different set of factors confront the first months of the administration, namely the Federal Reserve Chairman has resigned, requiring immediate response as to a new appointment. The last Chairman, as Bernanke twelve years earlier, was a proponent of a relaxed monetary policy, and had maintained a near zero target on the fed funds rate for an extended period. Additionally, prior to his resignation the Chairman signed on to a number of "bail out" measures deemed systemically crucial to the economy. While the Fed is an independent body, the choice of the Fed chairman reflects on the President's ideology regarding monetary policy. Additionally, a Chair for the Council of Economic Advisors must be chosen to lead the economic team. The choice of individual to fill this post will reflect considerably on the type of fiscal policy which will embody the administration's plans for the next four years. These appointments along with a blueprint for economic growth will be presented in one week at a Joint Session of Congress.

Appointee: Fed Chairman and Monetary Policy

The current economic situation which faces the new administration presents a negative growth pattern in GDP, an unemployment rate above 9.5%, a declining dollar, and burgeoning federal deficits. In considering first the appointment to the Federal Reserve, the new Chairman will have to subscribe to a policy of targeting the fed funds rate according to the so called "Taylor Rule." The Taylor rule is a formulaic mechanism developed by Stanford Professor John Taylor which if used properly can be a consistent adjustment lever for interest rates. Taylor's formula is fairly straightforward and "says that the federal funds rate should equal 1.5 times the inflation rate plus .5 times the GDP gap plus 1" (Economic One. September 1, 2010). The previous Fed chairman had adopted a near zero target for the fed funds rate and had articulated holding that rate until the unemployment rate moved down considerably, a sign of economic growth. The new Fed chairman could certainly argue that the zero rate should be in effect now however, going forward the monetary policy would necessarily follow the Taylor rule and its guidance on interest rate policy.

A second crucial ideological component for the new Fed chairman is a commitment to combat incipient inflation to ensure the stability of the dollar's purchasing power. Following the blueprint of the Taylor Rule the fed funds rate target will increase as signs of inflation pick up in wages and commodities. An extended near zero policy on the fed funds rate achieved through open market bond buying operations encourages bank lending, resulting in the growth of the money supply through the money multiplier (Mankiw, G. 2004). The new Fed chairman would necessarily have to monitor inflationary pressures to prevent spikes in the cost of living. On this note the new Chairman would move from a policy of targeting core inflation which excludes the so called volatile food and energy prices, and focus on the headline rate which includes these components. Additionally the Consumer Price Index calculation would change to reduce the weight of housing in the index, "which makes up 41% of the typical consumer's budget" (Mankiw, G. 2004). More weight would be placed on those items which have steadily increased in price far above even the headline rate over the last decade: energy, food, health care, and education. These steps would help stabilize the dollar as a store of value for the consumer and investor.

The last selection criterion for the new chairman will be their belief in the purpose and efficacy of the prior chairman's avocation of several "bailout" measures designed to prevent against systemic risk in the system. The discussion of this topic and additional policy measures will follow later in this exposition.

Appointee: Chair of the Council of Economic Advisors and Fiscal Policy

The Council of Economic Advisers, an agency within the Executive Office of the President, is charged with offering the President objective economic advice on the formulation of both domestic and international economic policy" (White House.gov. N.D). The choice of the Chair of the Council provides considerable insight into the economic policies the administration will follow. In choosing the Chair there will be four distinct criterions: tax policy, trade policy, regulatory policy, and government spending.

On tax policy the administration strongly favors a policy of lower marginal tax rates on individual and business: income, dividends, and capital gains. The lower tax rates will accompany a reduction in deductions and loopholes which will considerably broaden the taxable base. The reduction in tax rates foster an environment in which savings and investment flourish, and capital stock requisite for producing a long-run growth cycle is created. "Economists agree that a large capital stock is a key ingredient for prosperity, as it expands our productive capacity and raises worker productivity, which in turn increases wages and consumer purchasing power" (Cooley, T. & Ohanian, L. December 8, 2010).