Macroeconomic Policy and Its Impact on Airline Industry

Monetary and Fiscal Policy as Economic Tools

Monetary and fiscal tools are used by governments to control economic conditions within a country. Monetary policy usually targets the money supply in the market in order to control inflation. In some countries, such as Russia and Brazil, governments may force their mints to print extra currency to meet various expenses. This results in a higher flow of money in the market that is unsubstantiated by the country's gold reserves, leading to inflation and causing several problems due to macroeconomic instability.

When inflation is kept in check, prices stay within consumers' reach and the money market remains stable, positively affecting other areas such as employment and interest rates. Monetary policy is more dependent on market forces and consumer behavior, whereas fiscal policies encompass governmental spending, taxation, and interest rates. Fiscal measures are normally utilized in capitalist countries when economic conditions move beyond the control of normal market forces and government intervention is required. In some countries, including Japan, fiscal measures play an extremely important role in the economy, whereas the United States has been comparatively reluctant to rely on fiscal policies.

The two most important fiscal measures are tax reduction and lower interest rates. When businesses stop producing an adequate amount of goods and services, the government encourages them by offering attractive incentives, mostly in the form of lower interest rates. These reduced rates make borrowing easier and induce producers to invest more in their businesses and increase production levels. However, a key reason why producers reduce output during tough economic times is a lack of consumer interest. Consumer spending shrinks dramatically, less is spent on goods and services, and this automatically results in lower production — a straightforward application of the demand-and-supply relationship that becomes more pronounced during periods of economic difficulty.

How Fiscal Measures Affect Business and the Dollar

The fiscal measure of tax reduction can induce consumers to spend more as their purchasing power increases. The government effectively puts more money into the hands of consumers to encourage spending, which may result in higher production. These measures do not always work, but if carefully planned they can have a positive impact on economic conditions. In the United States, for example, the government reduced interest rates eleven times after September 11, 2001, in order to increase consumer spending and stimulate borrowing activity (Berry, 2001). However, it is widely acknowledged that when fiscal measures are not carefully planned, the desired results cannot be achieved. This is what happened when frequent tax-reduction announcements and cuts in fund rates failed to bring about positive changes in business activity, and many corporations failed in succession. Fiscal measures should therefore be adequately supported by other means — such as increases in deficit spending and careful budget allocation — or the exchange rate is seriously harmed as the dollar weakens against other major currencies including the Yen and the Euro.

This is an important concept for understanding how fiscal measures affect the value of the dollar and how fluctuations in the dollar's value in turn affect economic conditions. As noted above, tax reduction unaccompanied by other important measures can negatively affect the dollar's value. If the dollar weakens, GDP growth suffers because revenues earned from exports become inadequate, which can have a profound impact on the profits of business corporations in the country. While the United States has used both monetary and fiscal measures to control economic conditions, its fiscal policies appear to have been more successful overall. The main problem with monetary measures is that they can lead to a sharp drop in inflation, triggering a major economic downturn. Inflation within limits is always more desirable than no inflation or deflation. For this reason, monetary policy must always be carefully implemented, as its negative effects can often outweigh its positive ones.

The rate of inflation is tracked with the help of the Consumer Price Index (CPI). The CPI is an index that records changes in the prices of goods and services over a specific period of time. The U.S. Bureau of Labor Statistics is responsible for calculating the CPI by aggregating data across various industries in order to compute the cost of living more accurately. Since the CPI includes a "basket of goods and services," every good and service that an average American is likely to use is factored in — and this obviously includes travel.

The U.S. airline industry has attracted more attention in recent years than almost any other industry in the country. Despite numerous financial difficulties and persistent operational challenges, this industry has emerged as a real survivor.

Inflation, CPI, and the Airline Industry

Three main best practices that helped the airline industry stay afloat were identified by Brock (2000), who argued that the industry managed to avoid complete financial collapse during the economic downturn of the mid-1990s by adopting the following three strategies:

While alliances and mergers helped many airlines survive during periods of extreme economic slowdown, it was primarily the pricing tactics that worked for the largest players in the industry. Brock maintains that "during the 1990s, the main carriers have repeatedly resorted to sharp, tightly focused price cuts that corral low-fare independent carriers and prevent them from obtaining and expanding competitive footholds in important routes and markets."

Airline Industry Survival Strategies

This claim has some basis in fact. In the late 1990s and early 2000s, smaller airlines lodged complaints alleging that major carriers were engaging in predatory pricing. In response, the U.S. Department of Transportation (DOT) even considered issuing specific guidelines to define and regulate exclusionary pricing practices. However, the DOT ultimately decided not to publish those guidelines, and a lawsuit against American Airlines was dropped when no predation could be detected. The court ruled in favor of American Airlines, stating:

"The government's claims in the present case fail because American did not price below an appropriate measure of cost, because it at most matched the prices of its competitors, and because there is no dangerous probability (even assuming below-cost pricing) of recoupment of American's supposed profits by means of supra-competitive pricing."

Furthermore, while aggressive pricing strategies may have affected some smaller carriers in the past, the emergence of many new low-fare airlines in recent years suggests that predation is not a tactic routinely used by larger players to block new entrants. This is supported by the fact that several low-fare airlines that entered the market in the mid-1990s — such as ATA, AirTran, and Frontier — all managed to grow within a short span of time. Similarly, JetBlue, a relatively new entrant at the time, became highly successful, suggesting that while major carriers may adopt unique pricing strategies, those strategies are not predatory in nature.