Question

1. The unemployment rate was "very high" between 2008 and 2014. The US federal government, in order to propel (stimulate) the economy implemented some stimulus packages in 2008 and 2009 (being the biggest one the American Recovery and Reinvestment Act of 2009, for $787 billion, which included an increase in government spending and tax cuts).

Some economists (including Nobel Prize winner Paul Krugman) argued that the “packages” were too small (and then they even asked for more!); however some other economists argue that stimulus packages are not very effective and mostly increase the (government) budget deficit and thus the (government) national debt.

Furthermore, in late 2007 the Federal Reserve System (the FED) started reducing interest rates (using its conventional tools of monetary policy) to stimulate consumption and investment, and as a result interest rates have been low for more than a decade (for instance, the federal funds rate target was between 0 % and 0.25% between December 2008 and December 2016). However, even though interest rates are still low today, banks are not lending as much as in the past, mainly because they are still concerned about the future of the economy (In August 2018 almost 700,000 people left the labor force in the US!).

In addition, to provide more liquidity to markets (at low interest rates), in late 2008 the FED started pursuing "quantitative easing" QE (an unconventional tool of monetary policy that consists in buying longer-term Treasury securities and other (risky) securities such as commercial paper and mortgage-backed securities, among others, from financial institutions and private companies). This QE monetary policy was applauded by some economists, but it also received critiques. The last QE program (QE3) ended in late 2014.

Answer the following questions:

a) If Jerome H. Powell asked for your economic and financial advice, would you recommend him to keep pursuing "quantitative easing"? Yes? No? Why? EXPLAIN. (If yes, what would be the main problem? If no, what alternative would you recommend to him?)

b) The government receives information that there is a big chance that the US economy will experience a new recession, and that, as a result, the unemployment rate may increase to more than 10%; in particular, the current “trade war” between the US and China threatens to reduce significantly our exports and increase significantly the price of imports, which would negatively impact GDP and employment in the US (and the world). If President Trump and Steven Mnuchin, the Treasury Secretary, knew with certainty that Congress would fully support a new stimulus package that they proposed, and President Trump asked you for advice, would you recommend him a new stimulus package? Yes? No? Why? EXPLAIN. (If yes, should it be "big" or "small"? If no, what alternative would you recommend to them?) Use no less than five lines to explain your answer to each of the questions.

Answer 1

a. No, the policy of Quantitative Easing should not be pursued longer. This is because quantitative Easing or fall in the level of money supplied lead to fall in the rate of interest in the economy. This leads to capital outflow from the economy as rate of return for the investors will fall and they will invest in other countries offering a higher rate of interest. This capital outflow from the country will lead to depreciation of currency and thus economy will have to suffer from weak currency.

b. Yes, the stimulus package should be implemented to prevent fall in the rate of growth in the economy or prevent the economy to move into recession as the level of net exports in the economy. but initially the package should be small because a high stimulus package will also increase budget deficit for the government and this might lead to crowding out impact private investment in the economy. Thus, it can be stated that stimulus package should be implemented but with initially it should be kept low.