Macroeconomic stability free essay sample

Keynesian approaches in achieving long run macroeconomic stability The two schools of economic thoughts have different perspectives on how macroeconomic stability can be achieved. Keynesian economics became prominent when John Maynard Keynes introduced the concept of active participation of government in stabilizing the economy. This was because the private sector alone was not able to sustain stability due to inefficiencies in the free market philosophy that was the premise of classical economics. Keynes advocated two important policy models that would ensure continuous macroeconomic stability and is based on interest rate policies, tax policies and spending during different times to smoothen the business cycles which are responsible for macroeconomic instability (Roncaglia, 2011). These policies are known as fiscal and monetary policies and its objectives are to ensure stable prices, reduced/stable inflation rates, employment and production. Keynesian theorists can achieve macroeconomic stability by use of expansionary fiscal policies during economic downturns like in 2008. Interest rates should also be lowered to increase money supply and consequently increase the aggregate demand. The two Keynesian approaches help stimulate the aggregate demand during economic crisis. During times of boom, interest rates should be increased and taxes increased in order to reduce the money supply in the economy to avoid runaway inflation. Keynesian economic policies ensure that aggregate demand, employment, prices and production are maintained at stable levels with minimum fluctuations. Keynesian theorists also have various ways of achieving this goals through both the government and the central banks which have the mandate to use such policies. Monetarists approach in achieving macroeconomic stability Monetary theorists subscribe to the monetarism concepts which consider the role of governments in controlling money supply as the best solution to achieve long term macroeconomic stability. Milton Friedman is one of the prominent monetarists who argue that the economy is dependent on the supply of money in the economy. Therefore in order to achieve macroeconomic stability over time, governments need to constantly increase the supply of money. The supply of money however should be relative to the GDP of the economy because the supply of money directly affects any variable related to output. These variables are employment and prices (Ardalan, 2011). A common perspective in policy is to increase money supply. This calls for reduction of interest rates by central banks such that commercial banks and other financial institutions can access money cheaply from the monetary authority. This will lead to an increased borrowing from households and businesses (Lulla, 2009). On the part of households, aggregate demand will tend to increase thus sustain a stable supply side of the economy. On the other hand, increase in money supply increases investments by businesses and thus helps increase employment. The monetary policy of lowering the interest rates also can be directed to government securities. This is where the return on risk free treasury bonds are lowered such that people do not buy the so much but rather chose to spend the money. The effects is that demand will increase as well as private investments and thus high productivity and employment. These approaches however are not very sustainable since it easily can lead to inflation due to technicalities in computation of the appropriate rate of increasing money supply over time. Impacts of persistent budget deficits on the trade deficit and its remedies Budget deficit refers to the negative difference between the total governments’ revenues in terms of tax and it expenditure calculated within a fiscal period. The budget deficit is not considered a good sign since it means the government is spending more that it collects through various activities (Rossi, 2010). On the other hand the trade deficit refers to the negative balance between a country’s net exports and imports. Budget deficit in itself can be problematic because it means that the government is borrowing more to cover the budget. This means that the economy is constrained by lowered growth due to steps taken to fill up the deficit. Budget deficit means that government increased its expenditure and reduced it tax collection and to fill the deficit, it has to borrow from the public or increase its tax. Borrowing through sale of attractive government securities will result to crowding out effect in the private sector. Printing money to finance the deficit will lead to inflation. This therefore means that a sustained budget deficit has serious implications on the economy and the open economy will also be affected. Trade deficit represent the open economy in terms of exports and imports. Sustained budget deficits will lead to reduced imports if the government decides to increase taxes and cut its spending. On the other hand, the use of treasury bonds to borrow money reduces the demand for exports since the attractive interest rates shifts focus of foreign importer to the securities and not the local products being exported (Weerapana, 2003). This leads to a decline in exports in the long run if the budget deficit continues. The remedy to this challenge is to pursue a continuous policy that reduces borrowing from public, reduces government expenditure and increase tax to reduce budget deficits which tend to increase trade deficits over time. Reducing trade deficits can also be approached when there is increased national savings. In most cases, households save more in anticipation of future changes in the economy. Households will also save in order to pay taxes which they consider are deferred when there are huge budget deficits. Increasing taxes when national saving will therefore help reduce the trade deficits because it increases exports and reduce imports. Supply-side economists and government deficits Supply side economists believe in increasing the supply of goods and services as a way of taming various macroeconomic problems. These economists argue that there are several barriers to production of goods and services and if these barriers are removed or reduced, production will increase and prices will stabilize. Primarily, they identify taxes and too much regulation as a big challenge to economic growth and productivity. Increasing tax reduces the economic exchanges between agents in an economy since it takes away a proportion of profits earned. This leads to low demand and also low supply and higher prices which may discourage consumers. However, reducing tax rates increases investments and consumption alike (Rossi, 2010). Similarly, supply side economists argue that reducing regulations affecting the various economic processes increases the rate of economic activities and more investments. This view however conflicts with the running of the open economy. Reduced tax rates means government revenues against its spending declines leading to budget deficits and therefore the supply side economists do not provide the much needed remedy to economic growth. Their view is thus not adequately considered exports and imports and their implications on budget deficits. This is because when tax rates are lowered on income and capital gains, people will have lots of income to consume and consequently increase demand for imports. Although domestic production may increase, demand for imported goods will tend to rise. Similarly, the demand for imported goods will weaken the local currency due to high demand for foreign currencies and thus creating a huge budget deficit. It is also observed that the supply side economics also might not consider increasing tax even when national savings increase due to high income levels which will see extra income being saved more than it is invested. National economic policies and the magnitude of the trade deficit The US deficits have been rising in recent years due to policies that clashed with economic growth. For instance, the medical insurance program commonly known as Medicare/Medicaid has been heavily financed while revenues for the government reduced. This health policy is one of the national policies that contribute to the growing deficits. Income tax revenues from individuals have fallen by 3. 5%GDP while the tax from payroll also decline by 0. 8%GDP in 2011. Tax cut policies during and heavy financing of military activities have pushed the deficit gap even wider after the great economic recession. The recession complicated efforts maintain tax revenue collections and maintain exports at previous levels. The growing support for unemployed Americans after the crisis also lead to further deficits. The US economy has also been seen to depend highly on debt to fill its budget and resulted to China being the biggest holder of US debt. However, the US is pushing forward policies that will see increased national savings and pushing for China to allow flexible exchange rates system. Budgetary reforms also form core policy options to deal with the deficit crisis. Protectionist policies: its benefits and impacts on trade deficits Protectionism is the economic practice that employs strategies to cushion domestic industries from competitive foreign firms. Countries often want to ensure that their local industries grow and make profits. However, with international trade and globalization growing rapidly and inevitable, there need to be measures taken to ensure protect the local firms from competition. Most of protectionism policies include tariffs, environmental legislations, import quotas, export subsidies, exchange rates policies and other policies that favor local industries and put some pressure on the imports and foreign firms. Tariffs are basically tax rates that are subjected to goods imported. On the other hand, legislations like anti-dumping laws, standard settings and many compliance certifications imposed on imported goods are meant to control the consumption of imports (Rossi, 2010). These policies help governments to improve local consumption and growth of industries in order to compete with other international firms. The impact of these policies is reduced or controlled imports and somehow increases exports. It is however not sufficient to boost exports since almost every country also practices some sort of protectionism in international trade. Nevertheless, a protectionism policy helps to boost trade balance since it restricts unnecessary imports. Countries like the US whose trade deficit and budget deficits are high are employing policies that have been criticized to be protectionist in nature (Russell, 2013). These policies are sometimes hard to identify as protectionist. China’s pegging of its currencies against other currencies has been labeled as protectionist despite being acceptable in the global money market. Countries like US can however consider protectionism to tame the rising demand for cheaper imports from china.