Macroeconomics Problem and the Current Situation in US

Introduction

The current financial crisis in America is partly being blamed on poor economic policies enacted and implemented by the Bush administration. Though the policies have in part been in use for the last eight years, they are pointed to have been the cause of the present crisis. Such is the relationship between short-term and long-term economic problems. This is to say that a macroeconomic policy might have a good impact on some aspects of the economy in the immediate future, but after a number of years, the results might be completely different (Case and Fair, 2006). In this paper, we look at the main macroeconomic issues and assess how they impact the economy both in the long run and in the short run.

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Current situation

The US economy is in a crisis. Financial services companies are coming down in large numbers, with most being bailed by the government. Employees are worried t the current levels of unemployment standing at over 6%. Inflation is also on the rise. In short, in the few months that the financial market has been in trouble, consumers and investors have panicked a lot and made rash decisions with far-reaching implications in the short run and in the long run. Many are withdrawing their deposits from banks in fear that they may collapse. In short, there have been panic withdrawals, thereby worsening the conditions further. This can be seen as the short-term implications of the high inflation and financial crisis in the economy.

Unemployment

In any given economy, a certain age group of the population and main persons between the ages of 21-65 constitutes the economy’s labor force. According to Reinhardt (2006), this number of people is the main contributor to the national Gross Domestic Product (GDP). Classical economists describe the labor force as the number of people in an economy ready to exchange their services for salaries and wages for the prevailing wage rates. They are again the highest taxpayers providing revenue to the government to run its activities. Factories and industries require labor input from the labor market to facilitate the production of goods and services. The labor market is guided by the general law of demand and supply through complications arise due to various factors such as level of skill and mobility of labor. Such factors, according to Reinhardt (2006), have their own way of producing unemployment. So what is unemployment in the first place? Going by Lawrence’s (2003) description of the term, he says that it is a percentage of the number of people that are considered to belong in the labor force but cannot find employment. This brings to our attention the fact that students and the aged are not considered as part of the labor force; hence they are not included among the unemployed. Another definition favored by the Keynesian school of thought is that “unemployment is an excess supply of labor resulting from a failure of coordination in the market economy” Classical economists, on the other hand, define unemployment as “people engaged in the productive work of looking for a better match between worker and employer.” They, therefore, view the search for work as work in itself. Thus we can deduce that the unemployed are workers working the “job search sector.”

Unemployment is considered only a problem in the economy when it exceeds the recommended level of 4%. This level is encouraged as full employment; in this case, 0% unemployment, production will be impossible. Pharis (2007) the recommended 4% is only to cushion the labor market from unprecedented wage hikes resulting from high demand and low supply. The recommended rate is permanent as in the short run people will keep on switching employments. During this transition from one employer to the other, then there will always be a number of people unemployed in the short run, but in the long run, they will be employed.

Long term unemployment

Long-term unemployment periods can be related to lower transition probabilities from job search to employment. Secondly, the long term unemployed workers “are less relevant to wage and price formation than the newly unemployed” (Llaudes, 2005).

The author base’s his argument on the assumption that “the long term unemployed play a marginal role in the wage formation process.”

From this, we deduce that unemployment durations do not count in the setting of wage rates in the labor market. This is contrary to what is predicted in the Phillips Curve, which suggests that the long-term unemployed should receive more weight in terms of better employment conditions and wages. However, individual economic policies determine the role played by long-term unemployment. Llaudes (2005) notes that long-term unemployed persons in some Western European countries have a negligible effect on labor prices.

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Long-term unemployment can, in one or another, be attributed to short-term unemployment. This occurs due to the act that, after some time unemployed, individuals become disheartened and reduce their job search morale and activities, thereby decreasing their chances of finding employment. Again, according to the Phillips Curve, employers are biased against long-term unemployed workers as they are assumed to be more expensive by demanding higher wage rates. Therefore if firms consistently stick to this by hiring the newly “un-employed because they are assumed to be more productive and less costly, the equilibrium or “efficiency wage” is determined by the wage demands of this preferred group” (Llaudes, 2005).

According to the Bureau of Labor Statistics, unemployment in the US stood at 6.5% as of October this year. This is posed to continue with the economic situation in the country not that promising. Then we may ask ourselves what the role of government in reducing the unemployment levels in the country is. There are two major ways through which a government can influence the performance of the economy, not only in growth but also in solving some of these macroeconomic problems. In this year alone, the Bush administration has been lowering interest rates to encourage more investment and borrowing. This was a result reported a drastic drop in consumer spending since late 2007.

  • Types of unemployment.
  • Frictional unemployment.
  • Cyclical unemployment.
  • Structural unemployment.

Cyclical unemployment, in particular, is defined as an excess supply of labor and usually occurs in the long run. It results from delayed short-term unemployment periods, and according to the Phillips curve, it is supported by the labor market. On the other hand, frictional employment is caused by some people being between jobs, thus a short term, while structural unemployment is caused by problems that arise because of a mismatch between the needs of employers and the skills and training of the labor force. This might translate to either long-term unemployment or short-term unemployment depending on how far the employer is willing to compromise and high unskilled labor and then later train the employees (Case and Fair, 2006).

Economic stagnation

Economic growth is a long-term trend largely dependent on supply-side factors. Growth in the labor market and human capital, in general, is viewed as a key driver to economic growth though not always. Rueben (2007) takes note of China and India, which are heavily relying n their human capital for very rapid growth. Another factor that greatly contributes to economic growth, as noted by the same author, is investments in real capital stock. He says human capital facilitates individuals in the center to generate knowledge and new products and production methods when viewed on the supply side. From the demand side perspective, large human capital creates demand for goods and services produced in that economy. Unfortunately, differences in natural factors over different economies create variation in the effectiveness of human capital as a contributing factor to economic growth. In Africa, for example, high population growth rates are blamed for the unending poverty levels in the country. This is contrary to the above suggestions that increased human capital is viewed as an injection to the economy.

Economists and academicians have offered different ideas as to why the US economy is experiencing slowed growth. In any modern economy, some basic necessities must be ensured in order to guarantee growth. Most important, they must have a strong currency and a positive net exports balance. These three things are complementary to each other. A weak dollar, will in due course, lead to high oil and commodity prices through the multiplier effect. In the long run, this will lead to high inflation as we are experiencing now. In response, the Federal Reserve Bank is forced to raise interest rates in an attempt to protect consumers. This points to a very important revelation that a weak dollar does not cause economic stagnation but rather a weak dollar of any currency is a direct result of slowed growth or economic stagnation.

Case and Fair (2006) say that both long term and short term economic stagnation can be attributed to:

  • Weak Dollar.
  • Expensive Commodities.
  • Expensive Oil.
  • High Inflation.
  • Unmanageable Debt.

The current economic system in America possesses all of the above characteristics. The frustrating thing is that each is one of them is spinning out of control. In the last few years, the US economy has been on a growth recovery path after a slowdown caused by the terrorist attack of the World Trade Center. During such economic recovery periods, tax revenues are high, normally accounting for a large portion of the GDP. Unfortunately, normalization of growth after stabilizing recovery is interpreted as slowed growth. In the current “recession” period, we have seen the opposite as slowed growth.

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Data from the Federal Bureau of Statistics shows that per capita income in the US and growth in GDP have been on a steady increase in the last 20 years, with GDP growth averaging 1.8%. Unfortunately, this growth is not well represented among the low-income earning population. A report by the IMF released by BBC early last year shows that the difference in income between the rich and the poor is highest in developed countries contrary to popular belief that it is highest in developing and less developed countries. The US, as the most developed country, does not show its reported economic growth among the low-income earners despite the continued growth in the economy. Weiner (2008) says this points to the inefficiency of the GDP as a measure of economic performance/growth. He makes an example of the buying and reselling of houses at an ever-increasing price as being counted towards economic growth. Economists have for a long time relied on GDP as the most all-inclusive measure of growth in an economy. With the economic situation.

Inflation

Inflation is defined by Rueben (2007) as the general increase in price levels. According to the Federal Bureau of Statistics, the US economy had registered an inflation level of 6.5% in the month of October. This translates to say that while prices have remained constant, product prices have increased by 6.5%. Therefore the common American citizen has the same number of dollars to spend on expensive products. This now points to the difference in nominal and real wages. While there may be nominal increases of wages by employers to offset the inflation impact, the increase might not be enough to cover for inflation. Therefore, when the nominal wage is adjusted to inflation levels, we get a real increase in wages. When households receive a real increase in wage, consumption is bound to go up.

Types of inflation

Economists agree on three types of inflation, namely as:

  • Demand-pull inflation
  • Cost-push inflation
  • Hyperinflation

When demand increases and this results in inflation, we describe it as demand-pull inflation. On the other hand, when cost increases and this causes supply to decrease in turn, and this results in inflation, we describe it as cost-push inflation. But these two different causes of inflation are not independent, of course. Demand-pull pull inflation will more often than not lead to cost-push inflation. Continued inflation in the two categories creates hyperinflation. This is usually inflation in excess that may occur during a crisis such as war (Case and Fair, 2006).

Current situation vs. the great depression of the 1930s

Understanding the great depression of the 1930s is like the Holy Grail of macroeconomics, so says Bernanke, as quoted by Shane (2005). This has been the worst financial crisis to hit the world and the US. The current situation, as earlier said, is being compared to the Great Depression. But the thing is, we are not yet there, but we might be headed there if the government does not institute policies that will deliver the economy from the imminent danger. The Great Depression is said to have been caused by the Stock Market crash of 1929 in the US, but the other way that some authors see it as the crash had resulted from the depression had begun earlier than the agreed time of 1930 (Case and Fair, 2006). In the current situation, the financial and stocks market is in grave danger, with multi-billion companies reporting billions of losses and others filing for bankruptcy. Though the Stocks market crash of 1929 happened in one day, the effects are expected to be the same with a gradual crash as it is happening now. During this 1930’s depression, unemployment levels in the US had escalated to over 30%, with hundred of firms closing down.

Conclusion

The fact that the US economy has reportedly been on a growth path and the life of the ordinary American citizen has been worsening calls for urgent measures to evaluate the current system of measuring national economic output in terms of GDP as an indicator of the general economic position of a region. As earlier said, the disparity in wealth distribution is highest in countries reported as having the highest levels of GDP. In conclusion, therefore, the current method of using GDP as a measure of growth could be wrong in saying that the US economy. If other more competent measures were used, then it could be revealed that the US economy is worse-off than probably imagined and already in a bad recession.

References

Weiner, B. (2008). Introduction in economics, New York: Prentice Hall, pp. 111, 122.

Rueben, F. (2007). Macroeconomics, 4th ed. New Jersey: Sage, pp. 123-126.

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Reinhardt, S. (2006). Principles of economics, London: MacMilan, pp. 234, 236.

Pharis, Y. (2007). Modern economics, New York: McGraw Hill, pp. 450-453.

Kathleen, Murdoch, (2007). Economics of the great depression, London , Pearson, pp 208.

Keller, Michael, (2003). Modern economics, Boston: Bates, pp. 34.

Shane, K. (2005). Macro and microeconomics handbook, Boston: Wesley, pp. 23.

Llaudes, Ricardo (2005). The Phillips curve and long-term unemployment, No.441. 2008. Web.

Case, K. and Fair, R. (2006) Principles of Economics 7th Edition, New York: Academic Internet Publishers.

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