Discussion – Policies of the Federal Government

Discussion – Policies of the Federal Government

Economic conditions often inform the government’s policy changes. In the U.S, policies by the federal government influence economic growth and the creation of new businesses. The federal government usually regulates certain aspects of the country’s economy to engineer economic growth or prevent unfavorable economic conditions. A fair assessment would conclude that well-designed policies ultimately lead to economic growth while faulty policies affect economic performance. Therefore, it is important to analyze policy events and how they affect economic performance.

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High National Debt and Economic Performance

A budgetary plan that leads to high national debt can affect the economy through various channels. Essentially, a high national debt affects the economy by lowering national savings and income and increasing interest rates. In the first case, a high budget deficit decreases investment while increasing interest rates (Weinstock, 2021). The idea is that the government has to borrow more to repay its debts. As a result, a large proportion of the savings is devoted to settling bondholders. In turn, this situation reduces the invested amount in the private sector, slowing wage growth and increasing unemployment (Arize et al., 2014). This situation decreases the aggregate demand and, ultimately, spending. In the long run, the country’s GDP will fall because the labor supply can hardly recover, further dampening economic growth.

Accordingly, a high public debt raises the interest rate. Usually, when the national debt is high, the federal government tends to borrow more money to finance the deficit from the supply of loanable funds, such as bonds (Arize et al., 2014). The demand for these assets increases as the government increases its borrowing, eventually increasing the interest rate. Weinstock (2021) notes that the increasing interest rate is bound to crowd out private investment since firms can no longer borrow their capital investment. In the same vein, the high interest rates reduce consumer spending because of the high price elasticity of demand, leading to an economic downturn (Arize et al., 2014). As a result, the government is left with few options available to stimulate economic growth by financing various projects.

Effects of Tariffs and Quotas on Economic Performance

New tariffs and quotas on all imports are meant to act as a protectionist trade barrier. Foremost, tariffs raise the price of all imported goods above the world price by the amount of the tariff (Mankiw, 2021). Domestic suppliers who compete with foreign suppliers can now sell their goods at the world price in addition to the amount of the tariff. This situation increases the prices of both domestic and imported products, affecting the behavior of domestic and foreign customers. High prices reduce the domestic quantity demanded and, ultimately, the number of imports (Mankiw, 2021). Concurrently, the tariffs move the domestic market closer to its equilibrium without trade. Ideally, tariffs and quotas act as types of tax that distort incentives and push resource allocation from the optimum, leading to two effects (Mankiw, 2021). First, domestic producers increase their production to realize the maximum benefit of the high prices (Mankiw, 2021). Second, tariffs and quotas make domestic industries less efficient in the long run due to reduced competition with foreign firms (Mankiw, 2021). The overall price increase reduces consumers’ purchasing power but reduces unemployment for local companies.

Effect of High Unemployment on the Economy

The public’s loss of confidence in the government’s ability to manage the economy and create jobs has several consequences. One of these is the negative multiplier effect. Infusion of capital directly correlates with income and can have a snowball effect on various aspects of the country’s economy (Mankiw, 2021). Typically, some public sector workers may lose jobs if the government cuts spending. This situation will cause an initial fall in national income. Concerning this, the unemployed will have low purchasing power, reducing their demand in other sectors (Mankiw, 2021). People will also withdraw their investments to pay for basic goods and services. In turn, firms will reduce their production levels, further motivating them to lay off some employees.

Another effect of the high unemployment rate is skill loss in the job market. As the job demand increases, the salaries for those employed will decrease, or employers may lay off some staff rather than pay them high salaries (Mankiw, 2021). Additionally, employers may invest in innovative solutions to reduce the number of employees they need. For these reasons, some potential employees’ skills become obsolete as industrial and technological changes occur. New technologies and innovations always generate new and more productive jobs by de-bundling them into smaller tasks requiring new skills (Mankiw, 2021). Losing some skills in the labor market will render the country’s economy inefficient in the long run.

In addition to this, the high unemployment rate and loss of public confidence in the government may lead to socio-political consequences. The period of mass unemployment due to the government’s incapability will waste resources, increase poverty limits, redistribute social pressure, and promote social unrest (Mankiw, 2021). Moreover, political unrest may increase social problems, such as crime and vandalism. In the end, firms will not operate, with the remaining workers rendered jobless, eventually shrinking the economy.

Effects of Payroll Tax Cut on Economic Performance

Payroll tax cuts for those earning less than $250,000 per year would spur economic growth in the short term and reduce economic growth in the long term by causing prices and outputs in the economy to change. In the first case, lowering marginal tax will give people earning less than $250,000 per year more after-tax income that could be used to purchase more goods and services. This situation would push out the aggregate demand curve as high disposable income increases the demand for more goods and services. Furthermore, a low marginal tax would boost saving and investment, consequently increasing the country’s productive capacity (Huang & Washington, 2020). However, the employee-share payroll tax cut would not achieve economic growth in the end since the stimulus targets low- and middle-income earners who spend nearly all their limited income to meet basic needs. Huang and Washington (2020) observe that the economy is not affected by how much tax the wealthy pay. Relatedly, unemployed individuals would not benefit from the stimulus. During economic downtime, most people would be unemployed, with their low purchasing power decreasing the demand for commodities. Eventually, a payroll tax cut would not have any relative impact on the country’s economy.

Effects of Confidence in the Economy on Economic Performance

People and firms tend to spend less on investment in the face of low confidence as they believe the future pay-off would not be substantial. Worth noting is that investment spending is a component of aggregate demand, and a decline in investment will shift the aggregate demand curve to the right (Huang & Washington, 2020). In turn, this would imply that a large part of total spending occurs at every price level. As a result, the very people who support the corporate system would be disillusioned, depriving many firms of the required capital. The result will be an economic downturn as the GDP falls and unemployment rises.

Effects of Low Interest Rates on Economic Performance

Similarly, low interest rates would encourage investment and spur economic growth. The federal government imposes low interest rates to encourage borrowing by businesses to stimulate economic growth (Weinstock, 2021). However, banks would find it hard to pass on the interest rate decline to depositors. Some retail depositors would stash cash in a safe at home, shrinking banks’ net interest margin and their ability to supply credit. The cost of funding and banks’ ability to absorb risks influences the supply of credit (Mankiw, 2021). A low net interest margin would raise the cost of fending loans, increasing the bank equity capital. As a result, consumers would not have money to spend, reducing their aggregate demand and purchasing power. On the other hand, small firms would not have access to capital to boost their businesses, leading to a decline in the supply of goods and services. Therefore, sustained low interest rates adversely affect the economy and wealth distribution.

Summary

• The national debt affects everyone, including average individuals; a high national debt reduces the amount of tax revenues available to spend on other services.
• Interest is both an income and an expense to the government since the government has a significant amount of its national debt held by the public.
• The government uses tariffs and quotas to protect domestic firms and industries, despite the tactic shifting the equilibrium price upwards, making local goods and services more expensive.
• Tariffs and quotas cause a significant fall in economic growth since the government does not gain any tax revenue.
• A high unemployment rate impacts economic growth negatively in the long run since it wastes resources, increases poverty, and limits labor mobility.
• Lower income tax rates increase aggregate demand and, ultimately, the spending power of consumers, leading to higher economic growth.
• Low interest stimulates the economy and affects inflation, making loans more affordable while increasing consumer spending.

References

Arize, A., Kallianotis, I., Liu, S., Malindretos, J., & Panayides, A. (2014). National debt and its effects on several other variables: An econometric study of the United States. International Journal of Financial Research, 5(4), 98-113. https://doi.org/10.5430/ijfr.v5n4p98

Huang, C., & Washington, S. (2020). Payroll Tax Cut Is Poor Stimulus (pp. 1-6). Washington, DC: Center on Budget and Policy Priorities. Retrieved from https://www.cbpp.org/sites/default/files/atoms/files/5-12-20econ.pdf

Khoury, S., & Pal, P. (2020). Negative interest rates. Journal of Risk and Financial Management, 13(5), 90. https://doi.org/10.3390/jrfm13050090

Mankiw, G. (2021). Principles of Economics: A guided Tour (9th ed.). Cengage Learning.

Weinstock, L. (2021). Federal Deficits, Growing Debt, and the Economy in the Wake of COVID-19 (pp. 1-15). Congressional Research Service. Retrieved from https://crsreports.congress.gov/product/pdf/R/R46729

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The policies of the federal government influence the outcomes of the various activities in that economy. When government policies change or unplanned events occur, the resulting economic events or activity will usually change. Listed below are several policies or events that affect the performance of the economy:

The federal government employs a budget plan over several fiscal years that results in significant increases in the national debt, with no relief or plans to deal with the problem.
The federal government enacts new tariffs and quotas on all imports.
The general public loses confidence in their leadership, in terms of their ability to manage the economy, especially in the area of job creation.
The federal government, in an effort to stimulate the economy, decreases taxes on all individuals except those earning over $250,000 per year.
The level of investment decreases because of a lack of confidence in the economy.
Interest rates are kept artificially low by the Federal Reserve for several years.
For each of the items above, describe what would be the likely outcomes in the economy. Use the appropriate tools of analysis, such as aggregate demand and aggregate supply where appropriate, to justify and explain your answer.