Case Study Ting ZhangStudent Number: 3081857 POL 2320 – 051 INSTRUCTOR: Dougald Lamont SUBMITTED: November 28th, 2017Introduction:”An economy is not a machine” is anarticle published on October 19, 2015, the author Forbes explicitly presentshis point of view that the government is destroying the economy by inappropriatelyimplementing economic methods including adjusting inflation, carrying outmonetary policy and fiscal policy. Throughout the article, a mass of governmentmistakes is presented to demonstrate the severe errors made by the government,thereby distorting the marketplace including weakening the dollar, implementingzero-interest-policy, and increasing taxes aiming. Forbes starts with saying aneconomy is not a machine which cannot be manipulated, guided or driven (Forbes,2015). Following that, plenty of detailed examples are listed in the article tofurther support his point of view that neither the monetary policy nor fiscalpolicy used by the government is efficient.
Forbes is appealing to thegovernment to make wise and active government guidance, employing the right mixof fiscal and monetary policies, thus bringing perpetual prosperity. Forbes’sargument is not only to provide an understanding of the issues happening in theUS and the economic policies implemented by the US government, it is but alsoto appeal audience to think whether or not these government approaches really bringbenefit to the economics. By reading this article, it reminds me of variousprinciples we have learnt in the class such as the relationship betweeninflation rate and unemployment rate, pros or cons of monetary policy andfiscal policy implanted by the government. I believe that economy is not a machinewhich should not be operated as a machine. Relationship between inflation rate and unemployment rateRefer to “The Phillips Curve” named after William Phillips in below appendix, it showed an inverse relationship between rates of unemployment and corresponding rates of inflation that result within an economy. Stated simply, lower rates ofinflation will correlate with increased unemployment. It is mentioned in classlecture that The Philips Curve is an important formula, because for a while inthe 1960s, it was extremely successful at predicting.
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However, in1968, Milton Friedman asserted that the Phillips curve was onlyapplicable in the short-run and that in the long-run, inflationary policieswill not decrease unemployment (Friedman, 1968). Friedman then correctly predictedthat both inflation and unemployment would increase inthe 1973–75 recession (Friedman, 1968). On the other hand, it wasalso brought up that the rate of inflation has no effect on unemployment thelong-run which Phillips curve is now seen as a vertical line at the naturalrate of unemployment (Pettinger,2012).
In recent years the slope ofthe Phillips curve appears to have declined and there has been significantquestioning of the usefulness of the Phillips curve in predicting inflation.Today, most economists no longer use the Phillips curve in its original formbecause it was shown to be too simplistic. This can be seen in a cursoryanalysis of US inflation and unemployment data from 1953–92 (Friedman, 1968). There are several majorexplanations of the short-term Phillips curve regularity. To MiltonFriedman there is a short-termcorrelation between inflation shocks and employment. Economists such as Edmund Phelps reject this theory becauseit implies that workers suffer from money illusion. However, other economists, like Jeffrey Herbener,argue that price is market-determined and competitive firms cannot simply raiseprices. They reject the Phillips curve entirely, concluding that unemployment’sinfluence is only a small portion of a much larger inflation picture thatincludes prices of raw materials, intermediate goods, cost of raising capital,worker productivity, land, and other factors (Friedman,1968).
Friedmanmentioned that inflation is “Too much money chasing too few goods”. In otherwords, prices will increase if demand is growing faster than supply. Thisusually occurs in rapidly growing economies. It is mentioned in the classlecture that lower taxes, less regulation, and greater “labour mobility”(easier to hire and fire workers, less unionization) would be solution. The Phillips Curve is still acontroversy topic nowadays. While tremendousdifferent economist’s’ point of views towards the relationship of unemploymentrate and inflation rate are ongoing, it is difficult for the government to implementcorrect polices to control these two rates especially the relationship ofunemployment rate and inflation rate is still uncertain.
The consequences ofinflation fightingEdwardmentioned in his article that government is responsible for inflation (Edward, 2000). Inflation is caused by printing more money. The government’s monetarypolicies are responsible for this. Keynesian spending policies and ideology andthe abolishment of the gold standard have permitted the government todepreciate our currency. The answer is to eradicate state control of the money supply. We need to divestgovernment of its power to arbitrarily increase or decrease the money supply.
In addition, we must build in pressures toward fiscal responsibility by thegovernment with respect to the production of balanced budgets and reduction of debt.The federal government must learn to live within its means – governmentdeficits must be prevented. The establishment of the gold standard will stiflethe hidden and deceptive tax of inflation.
Inflation could be controlled ifgovernment were not able to monetize debt or manipulate reserve requirements. It ismentioned in the lecture that fighting inflation and all these economic policesoften get credit for the growth that took place. However, one of the thingsthat happened is that the price of oil plunged – which no one expected. Forexample, price of oil drops from $30 to $10 inMarch 2015. OPEC was acartel, and they opened the taps again. So that certainly helped with growth indeveloped countries but it had other effects. Theconsequences of inflation fighting were that Reagan, Thatcher, Trudeau all run deficits and borrow atnear 20% and laid a base for debt to come. It wiped out manufacturing in U.
S., UKand Canada because manufacturers can’t handle financing costs. It created”Third World Debt Crisis” because countries can’t handle debt repayments. Government money printingto pump up the economy is a blunder.
In the article of an economy is not amachine, Ludwig von Mises sardonically pointed out that government money printingto boost the economy is a blunder, for it cannot be as simple as to pump gasinto an engine: “an economy is not a machine” (Forbes 2015). According toMankiw et al. (2014), in the long run, excessive increasing in the quantity ofmoney causes inflation, which results in the value of money to fall and theaverage of all prices of goods and services to rise; the faster the governmentcreates money, the greater the inflation rate. Ratesof inflation are calculated using the current consumer price index(CPI), it measures changes in the price level of a market basket of consumer goods and services purchased by households (Forbes,2015).
Forbes pointed out in another article “FedFoolishness Festers” (2016) that 2% inflation specified as the avowed target tostimulate the sluggish economy is destroying the global economy. According to US inflation calculatorpublished on October 18, 2016, by the USgovernment, the latest inflation rate forthe United States is 1.5% through the 12 months ended September 2016. TheInflation Rates Graph below displays annual US inflation rates forcalendar years 2006-2016. The Federal Government is trying to push it to 2%; however,higher inflation will have negative impacts on economic and social consequences. Forbes believes thatthe government is not being efficient and encourages them to make wise andproductive decisions. Inflation is an issue that is being pointed out by Forbesthat the Federal government should consider not raising it too high. First of all, rising inflation leadsto the depreciation in purchasing power of a fiat currency.
For instance, it oftenresults in the appearance of rising prices when you attempt to buyessentials such as milk, wheat, meat, clothing, medical services, coffee, orelectricity. In the article, the given example illustrates this which is theFederal Government’s and the Treasury Department’s blunders in weakening thedollar in the early 2000s led to the false commodities boom. Secondly, risinginflation leads to a fall in real incomes.
It is important to realize that thepossibilities of having inflation with no increase in income. The income is thesame, but more money will have to be spent on buying goods. According to “FedFoolishness Festers” (2016), the Federal Government’s indicates that the 2%inflation would lead to a 3.5% rise in real wages, it illustrates that theinflation will not affect the real wage only if the wages keep pace withinflation. Usually, in the UK, inflation generates wages to rise, for employeesmay get 7% increase if inflation goes up to 5% (Pettinger 2011). However, it isuncertain if the reality will go toward the direction of what the US FederalGovernment’s said. Thirdly, rising inflation leads to a both personal andbusiness uncertainty in making (Forbes, 2015). High and volatile inflation isnot beneficial for building business confidence, the partly reason would be thedifficulty in making sure what the real costs and prices are likely to be.
Thisuncertainty might lead to a lower level of capital investment spending. Asshown above, rising prices, falling real incomes, and business uncertainty, these are the factors that affect the FederalGovernment’s money printing tostimulate the sluggish economysignificantly, and are also the factors that cause the negative results by therising inflation; therefore, the Federal Government should think wisely while making decisions on adjusting the inflation. How Does Monetary Policy Affect Economic Growth? Monetarypolicy is enacted by central banks by manipulating themoney supply in an economy.
Interest rates and inflation are both influenced bythe money supply, both of which are major determinants of employment, cost ofdebt, and consumption levels. A central bank either buying Treasury notes,decreasing interest rates on loans to banks or reducing the reserve requirementto implement expansionary monetary policy. All of these actions increase themoney supply and result in lower interest rates which creates incentives forbanks to loan and businesses to borrow.
Debt-funded business expansionpositively affects consumer spending and investment through employment. Some economists argue that the centralbank tries to maintain price stability through controlling the level of moneysupply which indeed plays a stabilizing role in influencing economic growththrough a number of channels. Since sustained increase in price levels isadjudged substantially to be a monetary phenomenon, monetary policy uses itstools to effectively check money supply with a view to maintaining pricestability in the medium to long term. Monetary policy has far reaching impacton financing conditions in the economy, not just the costs, but also theavailability of credit, banks’ willingness to assume specific risks, etc. It alsoinfluences expectations about the future direction of economic activity andinflation, thus affecting the prices of goods, asset prices, exchange rates aswell as consumption and investment.
However, opposite voice towards monetarypolicy that it will slow production and increase unemployment rate. Monetary policy: zero-interest-rate policy is anothercatastrophic mistake. There aremany methods used to control inflation, including some that work and some thatdon’t work without damaging consequences such as a recession. For example, controllinginflation through wage and price controls can cause a recession andhurt the people whose jobs are lost because of it.In thisarticle of “An economy isnot a machine”, Forbes pointedout that zero-interest-rate policy isanother error made by the Federal Government. The zero-interest-ratepolicy is mostly implemented after an economic recession when unemployment,deflation, and slow growth conquer (Nath, 2015). For instance, it took place incontemporary Japan and December 2008 through December 2015 in the UnitedStates, the aim was to raise inflation and to stimulate economic growth. As aresult of Japan’s incapable of resolving stagnation and deflation, theJapanese economy drop into a liquidity trap (Nath, 2015).
Thegovernment’s advocating declining the interest rate is in the hope that itcould appeal to business to borrow more money to ultimately achieve the goal ofexpanding the economy; in contrast zero-interest-rate policy is proven to bethe poison for the customary flows of credit (Forbes 2015). According to Pettinger (2012), a proactive monetary policy which includescutting the reserve ratio or permitting excessive money supply should be used asan expansionary policy to stimulate the economy. However, cutting interestrates is not guaranteed to cause a strong economic recovery, and expansionarymonetary policy may fail under certain conditions.
Forbes indicates thatthe government’s decision on implementing zero-interest-rate policy is not beingefficient since zero-interest-rate policy may fail under certainconditions, thus encourages them to make wise and productive decisions. Firstly, ifconfidence is very low, then people are not motivated to invest or spend,despite lower interest rates (Pettinger 2016). It illustrates by an examplegiven in “Fed FoolishnessFesters” (2016) that capitalexpenditures by businesses stagnated because of economic uncertainties. Inaddition, if in a global recession, then there might be a strong fall inexports which outweighs the improvement in consumer spending (Pettinger 2016). Moreimportantly, if the proactive monetary policy is carried out crackbrained,awful inflation might be caused before economy recovery. Pettinger (2012)indicates that if the Federal Government estimate inflation would be temporaryand there would be a greater risk of recession, the Federal Government maypursue expansionary monetary policy despite considering the excessive inflation.
On the other hand, simply cutting the interest rate may boost the economy in ashort run; however, in the long-term use of very low interest rates canlead to opposite effects, including the frightening liquidity trap (Nath,2015). The zero-interest-rate policy is proved to be another catastrophicmistake made by the government, for the influencing factors preventing theeconomy to be revved up have not been taken into deep consideration. How Does Fiscal Policy Affect Economic Growth? Fiscalpolicy is the term used to describe efforts by a government to influence thelevel of consumption, investment, unemployment or inflation in the economy. Thefiscal policy tools consist of tax policy, government spending, regulation orother measures. Monetary policy refers to the manipulation of the money supplyand interest rates by a central bank. Fiscal policy is typically contrastedwith monetary policy. It is difficult to evaluate the success of fiscalpolicy.
Looking back to the Great Recession of 2007-2009 in the UnitedStates the single largest fiscal policy proposal in economic history. Withunemployment rising in the fourth quarter of 2008, the Obama administrationproposed a government spending plan of approximately $800 billion (Pettinger, 2012). TheCongressional Budget Office (CBO) and Mark Zandi, chief economist forecasted that without the stimulus plan, the unemploymentrate in the U.S. could top out as high as 8.94% by October 2009 (Pettinger, 2012).
With the stimulus, the CBO suggested that unemploymentwould only hit 7.71% for the same time period. It resulted byOctober 2009, the unemployment rate was 10.1%. This was significantly higherthan the “no stimulus” worst-case scenario proposed by the CBO andZandi (Pettinger, 2012).
There are no clear answers to the question of whether ornot the CBO used the wrong formulas, whether or not the wrong stimulus wasused, and whether or not fiscal policy actually hurts the economy rather thanhelp it. It only can illustrate that fiscal policy remains an imperfect,inexact and uncertain macroeconomic tool. Fiscal policy: tax increases compound the FederalGovernment’s mistakes. Fiscalpolicy is another economic tool often used by the government to stimulate theeconomy by cutting taxes or increasing government spending (Forbes, 2015). However, if the government spends more than it collects in taxes, itresults in federal budget deficit (Forbes, 2015); therefore, the government will try to increase the taxes in the hopethat the budget will be balanced. Forbes indicates that the Federal Government compoundedtheir mistakes by increasing the taxes, for imprudent carrying out high taxpolicy cannot be comparable with pumping gas into an engine, the only thing itdoes is distorting things, thereby hindering progress (Forbes 2015). Forbes believes thatthe government should think wisely before increasing the taxes, since theincreasing taxes policy may distort things.
Firstly, accordingto BUS 1201 Custom Text (2016), taxes policy affects consumers and business’sdecisions. If the tax is low, consumers and business will have more money tospend on goods and services; reversely, it leads to the output of market demandshrink, thereby slowing down the economy. Moreover, increasing taxes causes moreand more local companies move their facilities in other countries in order toreduce their tax burden and have the ability to compete with companies in othercountries with low taxes (Forbes,2015). Furthermore, the high tax burdenand inappropriate government expenditure lead to weak domestic consumer andunhealthy property market. For these reasons, hastily increasing tax policy isanother wrong decision made by the government; they should anticipate all thepossible consequences before making decisions.
Conclusion:All inall, the economy recover of USA is not smooth because the economy is not amachine, it cannot be manipulated like a machine. The increasing inflationrate, decreasing interest rate, and raising taxes policies are the economicmethods of stimulating the economy, but they should be implemented wisely. Facingsluggish economy, it is necessary for the government to take prudent policyadjustments; nevertheless, how to appropriate utilize the economic methods to boostthe gloomier economy should be taken into deep consideration by the US government. Reference:Edward W.Younkins (28 October 2000) Montréal, No 70. Quebecoislibre http://www.quebecoislibre.
org/001028-11.htmFriedman, M (1968) “The role ofmonetary policy”. American Economic Review. Wikipedia, https://en.wikipedia.org/wiki/Phillips_curveForbes, S. (2015) ‘An economy is not A Machine’, Forbes18.
Forbes, S.(2016) ‘Fed Foolishness Festers’, Forbes 12.Mankiw, N. G.& Kneebone, R. D. & McKenzie, K.
J. (2014) (ed.) Principles of Microeconomics, Canada: NelsonCollege Indigenous. Nath, T.
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