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The following is my personal plan for dealing with the current economic
The economy is in a bad spot. The 2001 real GDP was estimated to be 9,214.5
billion dollars, and this year's real GDP is estimated to be 9,377.8 billion1.
Unemployment, however, has jumped a full percentage point from 4.8% to 5.8% since
the past year, and what used to be a Federal Budget Surplus of 206.8 billion in 2000 has
turned into a deficit of –168.1 billion2. Inflation has been falling, from 2.8% in 2001 to
1.2% this year3. If the inflation rate continues to fall any more, there is the risk of falling
into deflation.
With increasing unemployment comes the immediate risk of the economy falling
2004 to 5.6%4, which will only worsen the situation in the near future. Currently
predicted at best is a slow recovery for the economy, with consumer spending likely to
taper off and growth predicted stuck at 2.5% throughout most of 20035. What is needed to
1
Figures taken from the US Commerce Dept. Bureau of Economic Analysis (www.bea.gov). Estimates
based on 1996 prices.
2
Figures taken from the Economics 116a webpage.
3
Inflation rates computed from CPI figures from the Economics 116a webpage.
4
Economy Faces Slow Growth, Forecast Says, The New York Times, Dec. 5, 02.
5
Economy Faces Slow Growth, Forecast Says, The New York Times, Dec. 5, 02.
prevent recession now is a plan that will have immediate effects in decreasing
unemployment.
PART 2: PROPOSAL
My proposal on fighting the upcoming recession involves the use of both fiscal
and monetary policy. I advise first increasing government spending while maintaining
current taxes, which would increase GDP without affecting public consumption or
savings. Specifically, an increase by $120.6 billion would put the unemployment rate
back to desired levels. Much of the money would be allocated towards increasing
homeland security and foreign military operation spending, topics which currently have
the fixed attention of the nation. According to a recent New York Times article, military
spending in 2002 has increased since last year by $10.6 billion6; the public has shown
Reserve tighten the money supply through buying securities on the open market. This
would have the result of lowering nominal interest rates, which would encourage
investment. This will have the added benefit of increasing growth, and allowing us to get
out of our current growth slump, while decreasing the trade deficit.
PART 3: OBJECTIVES
This proposal would accomplish several of the listed objectives, and most
importantly would stave off the oncoming recession. By increasing government spending
without increasing taxes, GDP would increase, creating jobs and preventing rising
6
Pentagon's Urgent Search for Speed, Cushman, John. The New York Times, Dec. 1, 02.
unemployment. Without rising unemployment, the threat of the cycle of unemployment
the end of the year. Okun's Law, which has been shown consistent with empirical
evidence, tells us that for every three percentage points GDP rises, unemployment falls
by one point. In 2001 the unemployment rate was 5.8%. We want to lower this to the
billion this year, a 1.8% increase would correspond to a dollar increase of $168.8 billion.
spending is multiplied by the open economy multiplier (because the United States
economy is open, and therefore some part of any disposable income gained is spent on
Approximating the open economy multiplier as 1.4 for the US economy, an increase of
$120.6 billion in government spending is needed to trigger the effective $168.8 billion
increase. If we increase public spending by that amount, then we should see the quick
allocated to homeland security and military spending, will fulfill Goal 2, which is the
7
NAIRU estimate taken from the Economics 116a webpage.
Goal 3, increasing the growth rate of potential output, will be accomplished by the
proposal, by having the Federal Reserve buy securities, increasing the money supply and
therefore lowering interest rates. This in turn will reduce the cost of investing, therefore
raising public desire to invest by increasing the cost of spending money. The amount of
private savings will increase, which will increase total investment, as Gross Domestic
Investment (I) + Net Foreign Investment (X) = Private Savings (S) + Government
Goal 4, lowering inflation by at least two percent, will not be accomplished by the
plan. We believe that the current inflation rate of around 1.2% should not fall any lower,
because of the threat of deflation. However, in the near future, there might be a need to
lower interest rates, while maintaining unemployment as close to the NAIRU as possible.
The only way to do this would be to increase aggregate supply. This might be
now with larger budget due to increased government spending on homeland security
outlined under Goal 2, could move into the Iraq/Kuwait region to maintain stability. Once
secure, the region would provide a temporary source of oil that could be regulated in
prices and quantity, a source that would provide the needed cuts to supply costs to shift
aggregate supply to the right. This would effectively increase the growth rate of potential
output, aiding in accomplishing Goal 3, as well as lowering prices, i.e. keeping inflation
low.
Goals 5 and 6 are closely related. Goal 5, lowering the trade deficit, means some
accomplished by a decrease in the exchange rate, i.e. lowering the value of the dollar in
the global currency market, however, Goal 6 is to maintain the strength of the dollar. A
strong dollar necessarily means that imports will be more than they would be for a weak
dollar, and exports will be less, which means a smaller trade deficit corresponds to a
weaker dollar.
By lowering interest rates as outlined in the proposal, the trade deficit would
decrease, as the price of foreign goods increased in the United States due to a devaluing
of the dollar. This would accomplish Goal 5, imports would decrease and exports would
increase, while maintaining an open economy; there would be no need to impose either
taxes or tariffs to discourage imported goods. A decreased trade deficit, i.e. increased net
exports, means an increased net foreign investment, which aids the achievement of Goal
3, increased growth rate through increased investment. Goal 6, however, would not be
spending and use monetary policy in having the Federal Reserve raise interest rates will
pull the economy out of its current slump. Increasing government spending should be
easy, with control of the Senate and the Whitehouse under the GOP. This will pull down
rates, we will see the accomplishment of lowering the trade deficit and an increase in
proposal, we can stave off the oncoming recession and accomplish the majority of the
short-term goals.