The current state of the economy and an appropriate fiscal-monetary policy mix
The United States is the leading economy in the world with a GDP per capita of $49,800 (CIA, 2013). The 2008 global financial crisis had a high impact on the U.S. economy (CIA, 2013). The recessionary trends contracted GDP growth from mid-2008 to mid-2009. This has been the greatest economic deep since the Great Depression of the 1930s (CIA, 2013). The senate established funds to bail out affected companies. It also provided a fiscal stimulus package to stabilize the economy (CIA, 2013). However, an appropriate fiscal-monetary policy that is capable of pulling out the U.S. from the recessionary trends is still contested.
According to Blinder (2004), a fiscal policy is powerful when an economy is weak, and the monetary policy is adequate in offsetting lower interest rates (Blinder, 2004). The monetary policy is not feasible because the interest rates will have no effect on the US economy.
Therefore, Fiscal adjustments to the existing policy are required. Reduction of the deficit would contract GDP hence recessionary impacts will be eased. For instance, when the deficit is reduced by 1%, it will result in a 0.5 % reduction in GDP, and a 0.3% reduction in unemployment (Gravelle & Hungerford, 2011). The adjustment in interest rates will then be used to devalue the dollar, cushioning the effect of deficit cuts by increasing the net exports in the short-run.
In the long-run, the US would need to adjust and fix its budget deficit, which is currently unsustainable (Gravelle & Hungerford, 2011). An increase in taxes will enable the government to increase its revenue, thereby reducing the budget deficits. This will help the country curb deficit in the long run. It is critical to note that though the deficit reduction is likely to reduce growth, its responses are expected to be minimal (IMF, 2013).
Trends in inflation, GDP growth, unemployment, and budget deficits since 2006
The U.S. should follow China as an example, in growing its economy. China is one of the biggest growing economies in the world today. It has recorded significant growth in GDP, since 2006. Its growth in 2006 was 11.6%, and 14.2% in 2007. It recorded 9.6% and 9.2% in 2008 and 2009 respectively (Morrison, 2013). In 2010, its GDP grew by 10.4% 2010, and 9.2% in 2011, despite the global economic crisis.
However, it slowed in 2012, growing by a GDP rate of 7.8%. According to the IMF, the economy of China is projected to grow at 7.8% and 7.7% in 2013 and 2014 respectively. China inflation stood at 0.6%, 7%, 7.3%, and 3.6% in 2009, 2010, 2011, and 2012 respectively (CIA, 2013). The high inflation was due to the credit-fuel stimulus initiative by the government to instigate economic growth in the face of the global crisis (CIA, 2013). China recorded an unemployment rate of 9%, 4.2%, 4%, 4.3 and 6.5%, in 2006, 2007, 2008, 2009, and 2011, respectively. In 2012, its unemployment rate averaged 4.1%. The country had a deficit of 850 billion Yuan in 2011 (China Labor Bulletin, 2013).
Before trade liberalization in 1979, China was a closed economy. Its economic policies pulled the country’s economic growth down. Since the establishment of trade liberalization, the nation has grown to become the biggest growing economy in the world. Before 2008, the period of economic crisis, China’s fiscal and monetary policies were expansionary. This reflects the level of economic growth witnessed before the crisis (Maddison, 2007).
However, during and after the crisis China changed after its GDP started to decline. The unemployment rate began to increase, and its Foreign Direct Investment (FDI) declined. This confirms that this nation was also affected by the global recession. The Chinese government initiated economic stimulus packages by loosening its monetary policy. Domestic consumption was encouraged through domestic consumption.
The implementation of expansionary fiscal policy and an increase in government spending was also encouraged. This effectively curbed the effects of the global economic meltdown. This is opposed to the developed countries, which were heavily affected by the crisis. Despite its positive recovery from the recession, the China economy shows signs of a slowdown, and hence needs a sound fiscal and monetary policy that will rebalance the economy.
It is recommended that China adopts a more progressive fiscal policy through the reformation of the tax system. This would reduce the fiscal burden on the economy and individual welfare. The Progressive fiscal policy would allow China to align its tax revenue with the economic cycles with tight taxes during the boom and lose taxation during the slump. The Progressive tax system would also act as automatic stabilizers to the economy. Fiscal policy reforms would also monitor deficit targets.
However, China should not relax its exchange rate policy since the global financial system is still speculative and fragile. China should continue managing the exchange rates to protect its economy from any potential instabilities in the global financial systems. This is premised on the understanding that the world economy still has not recovered fully from the financial crisis. In the long-run, greater flexibility would then be allowed to maintain economic stability after the global financial instabilities.
Blinder, A. S. (2004). The case against the case against discretionary fiscal policy. Center for Economic Policy Studies, Princeton University.
China Labor Bulletin. (2013). Employment in China. Web.
CIA. (2013). United States. The World Factbook. Web.
Gravelle, J. G. & Hungerford, T.L. (2011). Can Contractionary Fiscal Policy Be Expansionary?. Congressional Research Service. Web.
IMF. (2013). Reassessing the role and modalities of fiscal policy in advanced economies. Web.
Maddison, A. (2007). The Organization for Economic Cooperation and Development, Chinese Economic Performance in the Long Run, 960-2030.
Morrison, M. W. (2013). China’s Economic Rise: History, Trends, Challenges, and Implications for the United States. Congressional Research Service. Web.