Question

In 2001, President George W. Bush and Federal Reserve Chairman Alan Greenspan were both concerned about a sluggish U.S. economy. They also were concerned about the large U.S. current account deficit. To help stimulate the economy, President Bush proposed a tax cut, while the Fed had been increasing U.S. money supply. Compare the effects of these two policies in terms of their implications for the current account. If policy makers are concerned about the current account deficit, discuss whether stimulatory fiscal policy or monetary policy makes more sense in this case. Then, reconsider similar issues for 2009–10, when the economy was in a deep slump, the Fed had taken interest rates to zero, and the Obama administration was arguing for larger fiscal stimulus. Why might many believe that the Fed should keep interest rates at near zero levels in 2016 and beyond as growth remains stagnant?

Answer 1

A tax cut was proposed by President Bush to help stimulate economy. Let us first see the effect of such an economic policy. Any government policy change such as tax cut or increase or decrease in discretionary government spending is a fiscal poilicy. Tax cut will help businesses and people save more money than before, and also there may be influx of foreign investors to reap the benfits of lower taxes in the US.

Therefore, this policy of tax cut will lead to increase in economic activity in the country, increase in exports as firms are able to earn more than before, as well as an increase in foreign investors in the country, thereby leading to fall in current account deficit ( as current account deficit shows balance of trade in the current year, higher export than imports means a surplus current account and vice versa ).

Increase in money supply by the Fed, the central bank of the country, would mean a lower interest rate ( that may push investors away from the country ) as well as an increase in economic activity in the country leadig to higher economic output, increased exports. It is ambiguous to fully expect this policy to either have positive or negative effect on the current account deficit in the country.

In my view, as I have mentioned above, a fiscal policy such as lowering down of tax makes more sense in addressing concerns of current account deficit than a monetary policy change.

An interest rate around zero makes the borrowing cost extremely lower thereby leading to more liquidity in the economy and consequently increase in economic activity in the country or revival of economic growth.