Introduction
The world’s largest economy has been a subject of very heated debates among political and economic analysts. Why? Because recent trends in the economy as portrayed by key performance economic indicators have shown some bit of laxity in the economy as compared to earlier robustness of this economy. Some have come up to say that the economy started slowing down since the September 11 terrorist attack but the effects of that attack are being felt now. Private investors such as Warren Buffet in March this year were saying that the US economy was already in a recession basing his argument on the performance of his businesses. Another more reliable source of analysis was the World Banks six month review of the world economy in April which put the US economy’s growth rate at a standstill if not negative. As a result and a confirmation of the influence of the US on the world economy, the growth in developing East Asia will shed around one to two percentage points in growth to around 8.5% in 2008 due to the unfolding financial turmoil in the US and the resulting global slowdown, according to the same source.
The Bush administration has been appreciative of this dire economic situation that has called for major economic reforms that will reverse the current situation and put the US on the right development track as before. Republicans and Democrats put away their differences to enact a bill that came to be known as the Economic Stimulus Bill of 2008 meant to revert the situation. Perhaps we first look into the prevailing economic climate that has necessitated the creation of such a bill.
The current economic situation in the US
Since the end of the cold war, the recovery process for the US has had its worst progress in the recent past, notably since the September 11 terrorist attack on US soil. In fact, the Economic Policy Institute in Washington described the growth (2001-2005) as mere tidings. Why such a rather seemingly harsh description? One may wonder. Certain aspects in the economy prompted such a description.
- Inflation was rising on an hourly basis
- Weekly wages were on the decline as compared to the periods before the attack.
- Household income has declined as prompted by inflation. From 1999 to 2004 it registered a 4% decrease.
- The rate of growth in employment opportunities registered a drop from a previous of 9.9% before 2001 to the current 1.5%.
- Such a drop in employment opportunities has led to many people giving up their search for jobs thus reducing the government earnings in form of taxes.
- Private household indebtedness increased to 70% compared to a 12% increase in personal income.
From a macroeconomic aspect, the above occurrences can be broadly attributed to
- The decline in consumer spending
- the current trade deficit in the world market
- the debt trap
- housing prices crash
- credit expansion
Trade deficit
For the uninitiated into the world of economics, a trade deficit refers to the net value difference between imports and exports of any given economy. For a deficit, it means that the imports are more than the exports such as the current situation in the US. Strong economies however are expected to have more imports than exports due to the diversity of their economies which mostly tend to rely on the exportation of manufactured goods rather than agricultural unprocessed products something that is more common in the less developed countries more so in Africa..( www.nytimes.com/2008/03/14/opinion/14krugman.html)
The world’s largest consumer of petroleum and petroleum products in the name of the US has very few oil reserves for her own consumption thereby importing oil to supplement her meager reserves. A recent report in March this year showed imports of goods and services stood at $206.4 billion as of January alone a record high compared to total exports of $148.2 billion in the same period thus a deficit of $58.2 billion. Of this oil, imports accounted for 13.1%. This was attributable to the sharp increase in world oil prices which in January hit $84.09 per barrel. The situation hasn’t improved any much as in much the prices for the first time hit a record high of $109.72 early in March before dropping but still remaining in the over $100 per barrel range. With the continuous weakening of the dollar, we expect the prices to keep on rising given that some of these countries that export oil such as Saudi Arabia and Venezuela are considering using other stable currencies in their trading such as the Euro, Sterling pound, etc (Economic Research Institute)..( www.nytimes.com/2008/03/14/opinion/14krugman.html)
Monetary policy
Monetary policies are meant to create sustainable output and demand environments for the proper functioning of an economy. With the US presidential elections slated for later, this year candidates have made it a point to make the issue of monetary policy take the center stage in their election pledges pinpointing the blunders of the current regime, what they are doing is capitalizing on the desperation of the ordinary American in these times of difficulties where employment, inflation and the general slackness in business associated with a slow economy becomes an everyday worry. Promises are being made about cutting the taxes to providing a conducive environment for business. ( www.nytimes.com/2008/03/14/opinion/14krugman.html)
The federal government has responded in various ways to the unfolding situation enacting measures that are expected to cut down on the rate of economic decline into the feared hole of an economic recession. Problems in the sub-prime mortgage market had been evident by early 2007, but the disruptions took a far more serious turn late last year when pressures spread to commercial banks both here and abroad. The Federal Reserve in its capacity to supply liquidity and calm markets in such situations is assuring banks of a backup source of funding through the discount window.
To enhance the utility of the discount window and encourage its use, the Federal Reserve reduced the spread between the discount rate and the federal funds rate last August. However, banks are reluctant to use this attractive discount facility because they fear that their competitors will see it as a sign of weakness, and pressure in term funding markets. In the last three years, the U.S. Federal Reserve has been accused of sleeping on the job by not tightening its monetary policy to confront steadily rising U.S. inflation. On the contrary, it is focusing on sustaining economic growth than containing accelerating inflation. Seemingly unknown to investors, the Federal Reserve also appears to have done away with its decades-long policy of preempting inflation. The new stand on such issues could greatly accelerate inflation further, prompting dollar depreciation more than it is at the moment and a sharp increase in U.S. bond yields thus a far more reaching effect on the economy. (Maurice, 2007)
Easier monetary policies will not forestall a period of economic weakness in the near term. Experience teaches us that sometimes it is likely to pass between a decline in interest rates and its positive effect on demand. Once financial conditions change, time is required for individuals to recalibrate, and then execute their spending decisions. Lower interest rates will not stop, only cushion, the correction in housing markets in the short term.
Devaluing of US dollar
The biggest competitor to the US dollar’s dominance in the world market has been the Euro which has remained more stable when compared to the dollar. Debates have taken place in the world projecting the US as a country that cannot stand on its own in the world without the support of other nations. Some have been harsh about this saying that Americans live beyond their means as enabled by the developing nations more so in Asia and Africa. The decline of the dollar thus is being linked to the concerned countries withdrawing their support and thus throwing the US economy in disarray. The weak dollar however means that US exports become cheaper to other nations while importing for the US is becoming increasingly expensive. This will in the long run bring a good reason for Americans to smile as the deficit in import and export will decline if economic formulas and theories are to hold.
The fall of Housing Prices
In the first quarter of 2006, median U.S. home prices increased by 10%, compared to the same period in 2005 (NAR). In the second quarter of 2006, median U.S. home prices increased by less than 4%, compared to the same period in 2005. Then we may wonder why people are complaining about a fall in home prices while there is proof that the prices are on the rise. Yes, they are doing so at a rather decreasing rate. These do not match with the inflation rate whatsoever which almost makes the increase insignificant. An increase in interest rates takes care of the remaining increase in housing thus the net increase is actually negative. Rather than interest rates, increasingly unaffordable house prices and rising inventories of unsold homes have been pushing home prices lower. California, Massachusetts, New York, Arizona, and Florida have been the hardest hit in this slowdown in house prices though the effect is taking place countrywide. (Maurice, 2007)
Between 2001 and 2005, the average wage increase was 1% compared to the 3% increase in house prices. Inflation at hand to reduce the real wage led to a fall in demand for houses and the eventual fall in prices as a result of excess supply and waning demand due to a reduction in the consumer’s purchasing power. With home prices out of reach for a growing fraction of the U.S. population, inventories of unsold homes have steadily risen. According to a U.S. Department of Commerce report, inventories of unsold homes in July 2006 reached an 11-year high. In 2005, these inventories had increased by more than 20%. The report also showed that home sales declined by 13% since July 2005. Though these statistics are suspect with sampling errors and subject to justifiable revisions, the trend during the last 3 months of 2008 has shown home inventories rising rapidly and home sale figures remaining low. According to industry experts, these statistics are underestimating the growth of unsold home inventories and the contraction of home sales. Commodity exporting countries will also fall into recession if home prices in the United States continue to decline thereby showing once again the US’s position as a world economic leader. A global economic recession will significantly reduce demand for major commodities in the world market such as agricultural produce and base metals. Oil and gold prices, however, will probably remain well supported by extreme global geopolitical instability and dollar depreciation. A global economic recession in 2008 will also have a significant negative impact on equity markets worldwide.
Economic stimulus Act 2008
With the looming possibility of a recession or the prevalence of one at the moment, the Bush administration sought to improve things for ordinary Americans by increasing the money supply to the households. The bill was passed into law in February this year giving the government authority to increase federal spending by 1% of the GDP in a span of two years. This amounts to about $152 billion. In a rare sign of bipartisanship among the democrats and the republicans in the congress and the senate, both sides agreed on the importance of taking stringent measures of evacuating the US economy from an imminent recession. The bill offers more dollars to spend to those who are willing to spend and thus discouraging saving. Tax rebates and loans are being extended to the American’s to help them cope.
The Outlook for Economic Activity and Inflation
Experience and economics teach that the reforms will have no immediate effect to salvage the current situation with the effects subject to considerable uncertainty. Economists whose view on this I do fully support is that we are going to see a worsening scenario as indicated by a further sluggishness in the economy’s growth and increase joblessness plus a sharper drop in house price. Adjustments in the financial market either locally or internationally will also take some time to return to an upward trend.
The recent occurrences in the economy have triggered a chain effect that is expected to be followed in the recovery phase of the economy. Building activities in the housing sector will continue to decline until the current inventories of unsold homes have been substantially reduced, and the demand side of the market is not likely to revive amicably until buyers sense that price declines are abating and financing conditions for mortgages are improving. This poses a serious challenge to the market given that 68% of Americans own homes and furthermore these constitute to a great extent the middle income and high-income earners thus passing the buck to the low-income earners who are surprisingly on the lower side of the economic chain and the last beneficiaries of any economic recovery measures. Consumer spending will be hampered by the effects on real incomes of a weakened labor market, rising energy prices, the effects of declines in the stock market, and home prices.
Business spending on capital factors should be held down by lower sales and production and by caution in a very uncertain economic environment that is heightened further by Presidential elections in November. Nonresidential buildings are likely to lose some momentum in the wake of both weak growths in overall economic activity and tighter credit. Some modest offset to these areas of weakness should come from export demand, which should be boosted by the lagged effects of recent declines in the dollar.
By itself, the Economic Stimulus Act is probably not enough to keep the economy from going into a downturn, but combined with the Federal Reserves rate-cutting, it should be enough to keep the economy from dipping into a recession or salvaging it from one. By midyear, economic activity should begin to benefit from several factors. One is the fiscal stimulus package that Congress recently enacted. The rebates that households are scheduled to begin to receive in May should provide a temporary boost to domestic consumption. Although the timing and the magnitude of the spending response are uncertain, economic studies of the previous experience suggest that a noticeable proportion of households are quite sensitive to temporary cash flow. Although economic theory suggests that they should bring forward some capital spending, past experience has been mixed. The decline in residential investment should begin to bear more fruits later this year as the backlog of unsold homes is disposed of; reducing what has been a significant drag on economic growth over the past two years.
Finally, the declines in interest rates that began last year should bear fruits and show improvements in economic activity as the stress in financial markets wears off.
References
Maurice, D. International Finance, London: Routledge, 2007.
Norman, F. Tracking America’s Economy, New York: M.E. Sharpe, 2007. Web.
Betting the Bank- New York Times 2008. Web.
US Congress Passes Economic Stimulus Bill, 2008. Web.