Question

For the sake of this class the desired goals are always Full Employment, Stable Prices and Economic Growth.

The US economy, as well as the rest of the world, has experienced a huge negative shock this year. It has caused unemployment rates to increase, GDP to decrease and while prices have been fairly stable that may not hold.

Question: Identify a potential policy change you feel may improve the US economy. Be specific, explain what the policy is, what the expected outcome of the policy would be. Include both the expected costs and benefits (by type, not dollar amounts).

Answer 1

Introduction: -

The Corona Virus Pandemic, has affected the world economy extremely hard. Establishments remain shut and people are unable to move out of their houses to buy goods or services. The end result of this is that the aggregate demand for goods and services is declining sharply.

Firms are making losses and are unable to recover from the same. As a result of this, prices of goods and services in the country is falling drastically and so is the gross domestic product which is the value of final goods and services.

As firms make significant losses, they fire employees and unemployment in the country is increasing. There are fears that the worst is yet to come and we could land ourselves in a situation wherein, recession and its ill effects could be much higher than the 2008 Global recession which the United States had triggered.

In view of this, it is critical for the government as well as the Federal Reserve to follow an expansionary fiscal and monetary policy.

The core aim of these policies is the increase the flow of money in the economy, which will help in keeping stable conditions. They have been described in detail as follows: -

Case Specifics: -

An expansionary policy can be either Fiscal Which is by the government or Monetary which takes place by the Central Bank which is the Federal Reserve.

For the purpose of this case study, we analyse the impact of a reduction in interest rates on the economy at present which is in recession. This policy is implemented by the Federal Reserve which cuts its Federal Funds rate which is the rate at which it lends money to commercial banks. In return commercial banks, reduce their rate of interest and funds are available much easily for consumers as well as producers.

What this seeks to do is to increase the flow of money in the economy. When the supply of money increases and it is cheaper for consumers to take a loan and investing does not give them significant returns, the overall spending increases. As the spending increases, so does the investment capability of producers as they also get cheaper loans. The unemployment in the country also decreases.

The down side however, to the Federal Reserve reducing the interest rates at such a critical time is that bad debts may rise in the economy when people get loans at a cheaper rate of interest. Also, as the currency in circulation is high, and the demand in the international market is also falling, the dollar may depreciate in value. If the supply of a currency increases with respect to its demand, the end result is that its core value begins declining.

Another demerit is that as dollars yield lesser interest rates, foreign investment in the country will dry up and those, which have already invested money would withdraw money and take their investments elsewhere.

We can explain the same with the help of the following diagram: -

Here we see that the quantity increases as well as supply curve shifts to the left. The demand also increases and the governments idea of being able to decrease unemployment and increase demand for goods and services would rightly be fulfilled.

Please feel free to ask your doubts in the comments section.