Sequestration refers to the reduction of budgetary costs by the United States federal government. In 2013, the federal government cut spending in particular categories of expenditure. Primarily, the cuts were on account of the Budget Control Act (2011) that were similarly deferred for some period by the American Taxpayers Relief Act (2012) till March when the law was implemented. According to Demaree, sequestration can be described as the practice of reducing obligatory spending in federal government budget (1). These cuts are occasioned when expenditure for the government surpasses the total income the government receives in one financial year (Sequestration 1).
It entails termination of the budgetary resource using consistent proportion. Additionally, the consistent decrease is mostly applied to entire projects, activities and programs within the budget account. Reduction in spending authority in United States, was roughly $85.4 billion as compared to $42 billion in the real cash expenditure in the financial year of 2013 (Sequestration 4). These cuts are divided uniformly amongst the defense as well as the non-defense groups. Some of the major agendas that are exempted include social security, federal pensions, veteran’s benefits and Medicaid.
In Sequestration, the organizations that finance research as well as the advancement of the country economy would see their budgets slashed from an average of 5.1 percent to 7.3 percent during the year 2013, and remain stagnant throughout up to 2021. This will result to reduction in research and development, which may result to a decrease in the number of job opportunities available. Additionally, sequestration occurs under PAYG Act of 2010, accompanied by numerous exceptions. In this law, national administration should keep on making payment to the collective security, old hands’ benefits, Medicaid as well as low-income entitlements for instance, the food stamps, additional defense wages and unemployment. However, Medicare spending cannot be reduced with more than 2 percent.
What Caused Sequestration
Sequestration was occasioned by attempts by tea party republicans to reduce spending on obligatory agendas for example, the collective security, Obamacare and Medicare. These programs required an Act of Congress in order to change the spending, and the Republican knew they could not get the senate to agree. In 2011, the Republicans and the Democrats differed regarding the perfect measures in diminishing deficit on the federal budget. The Democrats turned down Bush tax reduction request for those people earning over $250,000 by arguing that well-off people can easily meet the expense of high tax charges; thus, provide the federal government with high amount of revenue (Sequestration 2).
They leaned towards cutting spending in the budget for defense. Conversely, the Republicans argued that if the high-end taxes were increased, there would be sluggish in creation employment vacancies amongst the industries, and that obligatory prerogative agendas would foster culture of being dependent on one another. The impasse transformed into disaster because the present expenditures and tax slash pushed country’s obligation towards predestined maximum edge (Sequestration 3).
Sequestration may result to slowed economic growth because the government spending is a crucial component of the country’s GDP. Those businesses that rely heavily on government contracts may suffer due to the spending cuts of the government. The level of unemployment will increase because the federal agencies are not able to hire more people. In addition, a reduction in doctors’ salaries meant that some of them stopped offering Medicare; hence, patients seeking treatments had fewer options. Sequestration also leads to nationwide shutdown of poultry and meat plants because of the absence of inspection personnel.
Sequestration and Government Shutdown
The United States federal government has been operating on a reduced budget that was slashed by $80 billion as a result of spending cuts. Primarily, sequestration had already negatively affected the economic growth of the country. The impact of the government shutdown has been felt all across the country. For example, due to the government shutdown of 2013, many active grant and contract activities funded by the government are not easily approved, as the agency personnel are not readily available to approve the grants and offer supervisory support. In addition, shutdown of the government will result to limited access to personnel responsible for administering contract performance (Harrison 9). In case of cuts in spending, the grants officers will not be available, and the Grant Online System will be unavailable. As a result, federal operations or recipients who receive their payment will not receive their payments during the lapse.
Fiscal Policies Enacted By the United States’ Government during Sequestration
A fiscal policy utilizes federal government’s authorities of taxation and expenditure in stabilizing the business cycle. The policy is controlled by the executive and legislative arms of the federal government, which are in charge of spending existing revenues and collecting taxes. If an economy slowed down because of a shutdown, the appropriate fiscal policy to be enacted is one that reduce taxes and increases. Such a policy is termed as expansionary fiscal policy. On the other hand, when an economy is experiencing high inflation, contractionary fiscal policy is applied. This policy aims at decreasing the spending and raising taxes (Sequestration 8).
The United States government is using the expansionary fiscal policy, which is intended to increase spending and reduce taxes. This helps the country to achieve economic stability. Decrease or increasing the government spending works in a variety of ways. For instance, changing the flow of money to circular flow in an economy, reducing unemployment and increasing GDP. In order to restrict the economy, the government intends to reduce its spending. This would lead to a decrease in the country’s GDP, employment and inflation. Essentially, an increase in taxes results to an increase in price, which unless checked early could lead to high inflation. It is worthwhile to note that an increase in the price level results to higher inflation rate, which triggers increase inflationary expectations. In such a situation, inflationary expectations increases the aggregate demand; thus, a shift in the aggregate demand curve. The fiscal policy used by the government strives to smooth out business cycles through manipulation of the federal budget in maintaining just enough demand for keeping people working. By adjusting the level of spending and taxation, the federal authority can maintain high levels of stable prices and employment.
Figure 1: Aggregate Expenditure Curve Graphic Representation
Source: Organisation for Economic Co-operation and Development (2013).
Aggregate demand is described as the total expenditures on the gross domestic product. It is usually measured by GDP price deflators and the aggregate expenditures on the domestic production. High price level is related to a decrease in the aggregate expenditures, and low price level relate to an increase in the aggregate expenditure. Thus, Aggregate demand plays a similar role in United States aggregate market i.e. AS-AD analysis. The impact of the fiscal policy used by the United States government is evident. Essentially, the policy causes a shift in the aggregate demand curve.
Monetary Policies and Tools Currently Being Used By the Federal Reserve
The Federal Reserve is using various monetary policies and tools in order control supply of money in the economy. This is aimed at stabilizing the business cycles, reducing inflation and increasing employment opportunities. Besides, the use of monetary policies and tools is intended to promote economic growth. Operating under monetary policy ensures that banks and the government are transparent and accountable. Therefore, it calls for policy makers be precise regarding the underlying principle behind the policy measures. Importantly, policymakers should operate in the constrictions enforced by present status of acquaintance, and they ought not to be held responsible for any outcome, which is impossible to avoid.
The Federal Reserve has been practicing consistent approach in implementing monetary policies. The formulation of these policies is the only accountability of FOMC. It entails seven governors from FED, Federal Reserve Bank president and four of the remaining 11 regional presidents of the Federal Reserve Bank. The committee meets regularly to deliberate on the existing condition of the financial system as well as forecast for the impending development of the country. Furthermore, when the committee meets, it votes on directives to govern open market operations. In such cases, it specifies the intended value for central funds interests’ charge. Essentially, central funds charges are defined as rate that the reservoir organizations lend as well as borrow to from one another (Organisation for Economic Co-operation and Development 6).
In principle, the FED policy makers use three different monetary policy tools to control the spending of the government revenue. These tools comprises of OMO (open market operations), the discount rate as well as the reserve requirements. Notably, the most applied monetary tool used by FED is open market operations. The Federal Reserve is able to control the money supply and money creation process by using open market operations. Essentially, it uses open market operations to buy and sell the country’s treasury securities in order to effectively control the supply of money in the economy. As a result, it is able to control interest rates (Santow 12). As the amount of money in the economy changes, banks avail more loans to the public at low or high interest rates.
Federal Reserve System uses two types of monetary policies, which are expansionary and contractionary monetary policy. The expansionary monetary policy is used when the Federal Reserve System increases money supply, and lowers the interest rates. On the other hand, contractionary monetary policy is used once FED wishes to reduce supply of money in the economy and raise the interest charges; this is aimed at reducing the level of inflation in the country (Harrison 12). If the Federal Reserve sells the Treasury Securities, the banks will have fewer reserves to use to offer loans; thus, they can only offer fewer loans, but high interest charges.
The other monetary financial policy instrument used by the FED is discount rates. Essentially, Federal Reserve decides the interest rates charged to banks for borrowing from its reserves. The rate charged on borrowing from the reserves significantly affects the ability of banks to offer loans. For example, if Federal Reserve decreases discount rates, the reservoirs increase; hence, banks have access to a large pool of funds, and can offer more loans at low interest charges and boost money supply in the economy. Contrary, if it raises discount rates, it restricts the banks to borrowing fewer reserves rates. Thus, alterations in discount rates are frequently applied as an indication of the monetary policy measures.
Finally, reserve requirements also works as a monetary policy tool by the Federal Reserve. It further adjusts proportion of the reserves, which the bank should always have available for outstanding deposits. Fundamentally, lower or higher charges have an effect on deposit multiplier as well as sum of holdbacks reservoirs may have. If FED decreases the reserve requirements, the banks can utilize the available deposits in offering more credits; hence, increasing money supply in the economy (Santow 18). However, if it raises the reserve requirements, the banks can reduce the amount of loans offered; hence, decrease the amount of supply in the economy.
In spite the fact that the 3 monetary instruments affect moneymaking process carried out by the banks and can be used for controlling money supply, the most effective tool is the open market operations. It is very easily to use this tool as attested by the Federal Reserve. Essentially, the FED can sell or buy a significant amount of Treasury Securities in order to control the supply of money in the economy. Besides, selling and buying of these securities can be done in short period of time. On the other hand, the discount rate works only if the commercial banks borrow reserves from the Federal Reserve System (Organisation for Economic Co-operation and Development 10). These borrowings are often dependent on other factors apart from discount rates such as the health of banking system. Notably, the reserve requirements form elementary division of moneymaking banking structure. The reserves establish division of the banks resources involving loans as well as reserves. Since distribution of resources between loans and reserves is not achieved with ease, regular adjustments in the reserves requirements are required to control money supply. However, in most cases, banks tend to ignore these changes as they go for the highest reserve requirements.
The main goals of the United States government to use various monetary policies is to improve the economy and enhance its growth. Particularly, the monetary policy used seeks to achieve macroeconomic goals of stability, economic growth and full employment. It helps in stabilizing business cycle; hence, it reduces both unemployment and high rate of inflation. The monetary policy used in the United States is primarily concerned with price stability, which assists in keeping the price levels in check as well as reducing inflation. Importantly, both the monetary policies and tools used by FED help in stimulating the growth of the country’s economy by improving its production capacity. It is worthwhile to note that when production capacity increases, more goods and services are made available; thus, human needs and wants are easily met.
In conclusion, the Federal Reserve uses key monetary policies and tools in order to control the supply of money in the economy. It has been established that policies used are expansionary and contractionary monetary policies, and the monetary tools used are open market rate operations, the discount rate as well as the reserve requirements. Importantly, both monetary policies and tools play a key role in enabling the United States government recover from a major shutdown.
Work Cited
Demaree, Mark. “Top Echelon Poll: Sequester Cuts Having ‘No Effect’ on Recruiters.” PRWeb. N.p., 12 Mar 2013. Web. 6 Dec. 2013.
Harrison, Todd. Chaos and Uncertainty: The Fy2014 Defense Budget and Beyond. , 2013. Print.
Organisation for Economic Co-operation and Development. Monetary policy in the United States. Paris: OECD, 2013. Print.
Santow, Leonard J. Do They Walk on Water?: Federal Reserve Chairmen and the Fed. Westport, CT: Praeger Publishers, 2009. Print.
Sequestration: The Threat to Small Businesses, Jobs, and the Industrial Base: Hearing Before the Committee on Small Business, United States House of Representatives, One Hundred Twelfth Congress, Second Session, Hearing Held September 20, 2012. , 2012. Print.
