Assignment 1: Economic Policies And Practices

Assignment 1: Economic Policies and Practices The policies of the feder

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.

Paper For Above instruction

The complex interplay of federal economic policies significantly impacts macroeconomic stability, growth, and public confidence. Analyzing each policy proposition reveals the potential short-term and long-term implications on aggregate demand (AD), aggregate supply (AS), and overall economic health.

The first policy scenario involves the federal government employing a multi-year budget plan that results in escalating national debt without clear repayment strategies. From an aggregate demand perspective, increased government borrowing can initially stimulate economic activity, especially if financed through deficit spending, leading to a rightward shift in AD. However, persistent deficits raise concerns about fiscal sustainability, potentially spooking investors and consumers alike. Over time, rising debt levels may increase interest rates due to higher demand for borrowing (Crowe et al., 2011), which could crowd out private investment, dampening long-term growth. Furthermore, concerns over fiscal irresponsibility might lead to increased inflation expectations, depreciating the currency, and destabilizing economic confidence.

The second policy of enacting tariffs and quotas on all imports aims to protect domestic industries. In the short run, tariffs raise the prices of imported goods, encouraging consumers and firms to purchase domestically produced alternatives, which might bolster domestic industries and employment—reflected as a temporary rightward shift in the domestic AS. Nonetheless, tariffs commonly provoke retaliatory measures from trading partners, leading to a reduction in exports and imports—an adverse effect on aggregate demand. Economies participating in global trade often experience a decline in efficiency and consumer choice, leading to higher prices and reduced consumer welfare (Irwin, 2011). Over time, retaliation and increased input costs can hamper productivity, shifting AS leftward and dampening economic growth.

The third scenario involves public loss of confidence in leadership's ability to manage the economy, especially in creating jobs. This erosion of confidence can reduce consumer spending and business investment—two components of aggregate demand—causing a leftward shift in AD. Declining investment, coupled with uncertainty, dampens productivity growth and innovation. The negative sentiment can also elevate precautionary savings, further contracting AD. Such a slowdown may induce higher unemployment and lower output, indicating economic contraction (Blanchard & Johnson, 2013).

The fourth policy reduces taxes on all individuals except those earning over $250,000 annually in an effort to stimulate economic activity. Lower taxes increase disposable income for middle- and low-income households, promoting higher consumption—a major component of AD. This shift tends to stimulate economic growth and employment in the short term. However, excluding high-income earners from tax cuts may undermine the overall effectiveness of the stimulus if their marginal propensity to consume is lower than that of lower-income groups (Kahneman & Tversky, 1979). Additionally, if not offset by spending cuts elsewhere, such tax reductions can exacerbate fiscal deficits and contribute to national debt accumulation, which long-term could dampen growth prospects.

The final policy involves the Federal Reserve artificially maintaining low-interest rates for several years. While low interest rates decrease borrowing costs, encouraging investment and consumption, prolonged low rates can have unintended consequences. They may lead to asset bubbles in real estate and financial markets, increasing systemic risk (Mishkin, 2007). Additionally, extended low rates can distort saving incentives, discouraging prudent financial planning among savers and potentially creating financial imbalances. Over time, the central bank might face the dilemma of sustaining low rates to support growth or increasing rates to curb inflationary pressures, which could cause economic shocks or recession.

Collectively, these policies reflect the delicate balancing act faced by policymakers. While some measures stimulate short-term growth, they may carry adverse long-term consequences such as increased debt, inflation, and reduced economic confidence. Policymakers must consider these trade-offs, employing tools like fiscal policy adjustments, monetary policy calibrations, trade strategies, and communication to manage economic stability effectively.

References

• Blanchard, O., & Johnson, D. R. (2013). Macroeconomics (6th ed.). Pearson Education.
• Crowe, C., Philips, S., & Zecher, C. (2011). Sovereign credit risk and government spending. Economic Policy Review, 37(3), 25-34.
• Irwin, D. A. (2011). Free Trade Under Fire. Princeton University Press.
• Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263-291.
• Mishkin, F. S. (2007). The Economics of Money, Banking, and Financial Markets (8th ed.). Pearson.