The article discusses the impact the recession the USA was experiencing in its economy. It talks about the increase in prices as well as the increase in unemployment and it also discusses why this recession is unusual compared to all others.
Normally recessions in the USA start because the Federal Reserve Board raises interest rates in an attempt to reduce inflation created by increases in domestic consumption . This recession however is not caused due to this reason as mentioned in the article but because firms stopped purchasing capital and the amount of investment directed to technological equipment was reduced thus significantly reducing domestic consumption. Moreover despite Alan Greenspan’s reduction of interest rates in an attempt to increase domestic consumption but still the recession isn’t changing despite the fact that domestic consumption has increased.
In this portfolio therefore I am going to make an attempt to show which demand side policy would be the best so that the US government could escape this recession.
The first policy the US government could use would be an expansionary fiscal policy . According to this policy the government would reduce taxes and increase government spending. The immediate result of this would be that consumers would have greater income and investment would increase since an increase in government spending implies the construction of more roads, schools, hospitals etc. This would mean that there would be an increase in injections and a reduction in withdrawals thus helping the US economy get closer to national income at full level as illustrated in diagram 1.
However this policy would have several implications. On the one hand since consumers will currently have a greater purchasing power this will mean that spending will probably increase which may lead to demand-pull inflation . This in turn will force the Federal Reserve Board to increase interest rates thus forcing the economy again in another recession. On the other hand the government can’t increase government spending to a great extent because it will need some source of income in order to make that increase and since it will have reduced taxes it will have to find another source of income. This will be quite possibly loans which will be easier to pay off if the fiscal policy mentioned above is combined with a monetary policy
In this case the government would have to use an expansionary monetary policy . This would involve increasing the supply of money and decreasing interest rates. The immediate results of this would be that more money would be flowing in the economy and people will be discouraged of saving and encouraged to borrow. This would be so since saving money wouldn’t be as beneficial as investing and they will be encouraged to borrow since they won’t have to repay at such a high rate.
However this policy also has several implications seeing that an increase in the supply of money would decrease the exchange rate of the dollar. As a result the countries exports will increase because it will be more internationally competitive because the lower exchange rate will mean it will be able to provide goods at lower prices. However the phenomenon of imported inflation will increase because the conversion of the price of the imported goods into dollars will be higher than originally as a result this will lead the country to a balance of payments deficit . This will happen because it will spend more on imports than on exports. Moreover the decrease in interest rates may lead to over-consumption which will lead to inflation especially if this policy is implemented with an expansionary fiscal policy.
Diagram 2 shows increases in inflation as a result of expensive imports. The increase in withdrawals leads to a leftwards shift in the withdrawals curve which will make the country move further away from national income at full level as seen in diagram 3.
Critical Statement: Overall this article gave a lot of information so that the reader could achieve a well rounded opinion of the US recession and it also provided some of its causes as well as why this inflation was particularly hard to combat. However due to this fact the author didn’t analyze the information in depth and gave a very superficial view of the issue. Finally he failed to mention any other policies that the US could have used to combat this problem, in other words there was no critical analysis of it.