Question

Use the first web site listed below to find the budget surplus or deficit for the last 5 years. Use the second web site to find the unemployment rate during those same years. Explain whether you think fiscal policy was appropriate during the last 5 years, assuming the economy is at the full employment level when the unemployment rate is 5 percent. Make your reasons clear.

The Congressional Budget Office is charged with providing nonpartisan analysis of the economy and the budget to Congress. Go to their home page (see the URL below), click on “Historical Budget Data,” and then select the Historical Budget Data - Jun 2017. Open the excel document, select the Deficits, Surpluses, and Debt tab at the bottom and write down the numbers for the past 5 years, which are present in the seventh column, the Total Deficit (-) or Surplus.

http://www.cbo.gov/topics/budget

The Federal Reserve Bank of St. Louis maintains a free database of economic data called FRED. Go to the page (find the URL below), search on the term unemployment and click on “Civilian Unemployment Rate.” Look at the chart to get the unemployment rate over the last 5 years.”

Answer 1

One of the two primary aims of fiscal policy is to contain elevated levels of unemployment, the other being to support economic growth.

High levels of joblessness are detrimental to the economy as higher number of people out of unemployment lead to a decline in consumer spending, thus curbing economic activity. A decline in spending negatively impacts consumer-oriented companies. Also, high levels of unemployment lead to a decline in tax income of the government.

In order to alleviate high unemployment, the government can take measure to increase aggregate demand. It may reduce taxes in order to increase the disposable income in the hands of consumers. This is aimed at resuscitating consumer spending, which in turn, boosts flagging revenues of companies, thus allowing them to hire more staff or at least shelve layoff plans.

Apart from reducing taxes, a government can initiate programs which can directly create jobs, thus tempering the unemployment rate.

But one of the results of expansionary fiscal policy is that it puts pressure on government finances and can either result into, or increase deficit.

Looking at the fiscal deficit data provided by the Congressional Budget Office from 2012 to 2016, we can see that the deficit decreased until 2015 and then increased in 2016. The trend was the same when we look at fiscal deficit as a percentage of GDP (gross domestic product).

The Civilian Unemployment Data from FRED shows that the unemployment rate in the US continued to broadly decline through this period of five years. The period of full employment, defined as the unemployment rate being 5% or lower, was achieved from September 2015, with the rate remaining at or below the 5% level from that month onwards till the end of the aforesaid period.

Though it may seem at first glance, that the fiscal policy was misdirected as fiscal deficit declined when the unemployment rate was higher than 5%, and it rose when the rate fell to that level (and below), there’s an explanation for this.

Fiscal policies take time to impact the economy, sometimes several years. In the aftermath of the Great Recession, the US government took several steps to stabilize and support the economy. The impact of those measures can be seen on the declining unemployment rate in the given five year period. Thus, though the rate was above that can be considered full employment, the trend was a declining one, thus not warranting further fiscal policy action.

It is also important to note that during this period, monetary policy was at the forefront of containing unemployment and stimulating the economy. Thus, there was some pressure off of fiscal policy.

In 2016, though there was full employment, the fiscal deficit of the government increased because the economic growth was below trend. Thus, the government had to take steps to increase economic activity, resulting in a higher deficit compared to the previous fiscal.

An argument can be made regarding whether the government did enough to reduce unemployment, but this would not mean that the fiscal policy was inappropriate for the given period.