Eco 372 - Economic Recommendations

Economic Recommendations

August 7, 2012

ECO/372

Economic Recommendations

ECO/372

In December, 2007, an economic downturn began. A recession ensued and by September, 2008, it earned the name of the Great Recession (Yglesias, 2011). The unemployment rate, declining values in the housing market, increasing foreclosures, bankruptcies, the swelling federal debt, increasing food prices, and multiplying fuel prices demanded an economic response through fiscal policy and monetary policy. As a result of those responses, the United States is in a slow recovery phase. An analysis and recommendation of the current economic state includes an observation of the proprietorship of policy interventions.

Economic Factors and the Impact on Aggregate Supply and Aggregate Demand

Unemployment

The current unemployment rate is 8.2% which is essentially unchanged from the previous month of 8.3%. There were 163,000 new jobs added in July. The government reports 9,000 fewer jobs, and the private sector lists an increase of 172,000 on the payroll. In contrast to these figures, the job deficit in comparison to the employment numbers prior to the recession is 9.7 million. At this pace, it will take 10 years to return to full employment.

The unemployment rate is shifting the aggregate demand to the left. This is due to less spending power of the consumer. Output will follow shifting short aggregate supply downward. Long aggregate supply remains vertical.

Expectations

The central bank predicted that the economy would expand 2.5 percent to 2.9 percent in 2012, well below its June projection of 3.3 percent to 3.7 percent. For the following year, 2013, the Fed predicted growth of 3 percent to 3.5 percent, down from a range of 3.5 percent to 4.2 percent.

The unemployment rate, it predicted, would still be at least 8.5 percent at the end of 2012, at least 7.8 percent at the end of 2013 and at least 6.8 percent at the end of 2014 (McBride, 2012).

Other tools Bernanke has signaled are under consideration include lowering the interest the Federal Reserve pays banks to park their reserves at the central bank, currently at 0.25 percent, which could induce them to boost lending.

Another option would be to pursue a 'funding for lending' program like the one recently implemented by the Bank of England, whereby the Federal Reserve might provide cheap short-term loans to banks in exchange for guarantees that banks will resume lending to individuals and firms.

The aggregate demand may be unchanged based on these expectations. The initial forecast is positive. This would shift the demand to the right. However, the correction Mr. Bernanke makes lessens the degree of expectations. This will shift aggregate demand back. The actual degree of shifts to both AD/SAS is difficult to exactly ascertain.

Expectations make it difficult to specify precisely what effect it has on the AD/AS. The expectation from Mr. Bernanke, chairman of the Federal Reserve Bank, has a greater impact on society and the economy as a whole more so than Robert Jindel, governor of Louisiana, as an example. It does not eliminate the importance of expectations as shift factors. It simply means that economists are not sure what the net effect of a change in expectations on aggregate demand is (Colander, 2012).

Consumer Income

The definition of consumer income is the amount remaining after taxes and living expenses have been deducted from wages. This represents the amount of money a person has to spend, save or invest. It is also known as discretionary income or expendable income (WebFinance, Inc., 2012).

Personal income increased $61.8 billion, or 0.5 percent, and personal consumption expenditures (PCE) decreased $1.3 billion, or less than 0.1 percent according to the Department of Commerce, Bureau of Economic Analysis.

This is a very slight increase in personal income, and the consumption expenditures is a decrease. The effect on aggregate demand and aggregate supply is negligible.

Interest Rates

There are basically two types of interest rates. The long-term interest rate is determined in the loanable funds market. The long-term interest rate is the price paid for the use of financial assets with long repayment periods. Examples are mortgages and government bonds. The quantity of loanable funds supplied (savings) is equal to the quantity of loanable funds demanded (investment) (Colander 2010). The current 30-year fixed mortgage rate is 3.97%, and the 15-year fixed mortgage is 3.21%. The average interest rate on all loanable funds uses the 10-year bonds rate as a proxy which is 1.75%.

The short-term interest rate has shorter repayment periods such as savings deposits and checking accounts (Colander, 2010). The interest rate on savings deposits is 3.9%. As a note of comparison, the interest rate one year ago was 5%.

The aggregate demand in response to lower interest rates will shift to the right. This is due to the net result of more money available for expenditures investments. The aggregate supply will shift downward correlating with consumption of goods due to availability of money.

Recommendations

Following are