The US economic situation and recent monetary policy

The US economy is struggling to recover and finds itself in a vulnerable position. There are many determinants that have led to the downfall of the economy such as weak growth and high unemployment. The country is also currently in a debt crisis of US$ 5 Trillion. The clipboard discusses these problems and what can be done to shift the US away from its major debt crisis.

Turning to the first question, U.S. economic growth has been quite sluggish in recent years. For example, annualized real GDP (gross domestic product) growth has averaged only about 2.2 percent since the end of the recession in 2009. As a consequence, we have seen only modest improvement in the U.S. labor market. Not only has growth been slow, it has also been disappointing relative to the forecasters’ expectations. For example, the Blue Chip Consensus have been persistently too optimistic in recent years.

The recent financial crisis underlines that open market operations alone can be insufficient at times for meeting the Fed’s statutory mandate. Since the crisis, many economists and central bankers have argued that a macroprudential approach to supervision and regulation is needed, and this may affect conduct of monetary policy to maintain maximum employment and price stability.

During the credit boom, finance is available on easy terms and the economy builds up excesses in terms of leverage and risk-taking. When the bust arrives, credit availability drops sharply and financial deleveraging occurs. Wealth falls sharply, precautionary liquidity demands increase, desired leverage drops further. In the U.S. case, there were some idiosyncratic elements, such as subprime lending and collateralized debt obligations. But, in the end, the U.S. experience included the major elements of most booms: Too much leverage, too little understanding of risk, too easy credit terms, and then a very sharp reversal.

The U.S. recovery has also been subpar because it has been taking place in the context of a weak global economy. Historically, after a country experienced a financial crisis, growing foreign demand and currency depreciation have often led to a sharp improvement in the trade account that has put a floor under economic activity. In such circumstances, rising exports substitute for domestic consumption in supporting aggregate demand. This demand, in turn, encourages businesses to hire and invest. In contrast, this time the shock generated by the U.S. housing bust had global consequences, exposing economic vulnerabilities outside of the United States, especially in Europe. Under these circumstances, the scope for trade as a support for U.S. growth, while positive, has been very limited.

These two factors–the dynamics following financial crises and the weakness of foreign demand–help explain why U.S. growth has been weak, but I don’t think these factors explain why it has been consistently weaker than expected.

As the presidential election is rapidly approaching, little attention seems to be getting paid to the question that may affect voters the most: what will happen to the “easy money” policy? Given the tremendous amount of money the Fed has “printed” and the commitment to keep interest rates low until mid-2015, the election may impact everything from mortgage costs to the cost of financing the U.S. debt. Trillions are at stake, as well as the fate of the U.S. dollar.

http://clipboard.com/nazeer/boards/supersonicsurge

 

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