Money and prices in the long run and open economies dictate the financial market. As such, that is why factors such as domestic variables and foreign monetary policies are over-emphasized. Demand for money is thus affected by the domestic variables, which include interest rates, price expectations, and permanent income, among others. As such, this paper explores the financial market to reveal the viable strategies the US can adapt to secure reliable money and prices in an open economy on a long-term basis.
The state of US Financial Market
Over the years, the economy of the US has been in good shape, especially when compared to other countries. The economic well-being is attributed to the different engines of the economy – GDP, interest rates, investments, unemployment rate, among others. Despite the economic crunch experienced in 2008, the US managed to bounce back and record impressive data. For instance, between 2011 and 2015, the GDP, domestic demand, consumption, inflation rate, and economic growth significantly increased while unemployment, balance, and fiscal balance decreased at almost the same rates (Jin, Choi & Kwan Choi, 2016). It has not been without challenges given that investment, money, and exports decreased. Policy interest and trade balance increased while stock market fluctuated.
However, the US economy has remained to be among the largest in the world in spite of the daily challenges at the domestic level; the large economy accounts for 20% of global output. IMF credits it as the 6th highest per capita. In fact, the first five countries are ahead of the US because they are small nations such as Singapore and Norway (Jin, Choi & Kwan Choi, 2016). Services that put US economy on the global map are technology, health care, financial services, and retail. It is no surprise that more than a fifth of firms in Fortune Global 100 have their roots established in the US. Another significant base following the service sector is manufacturing. The US manufacturing represents about 15% of the global production. The manufacturing industry is the largest in the world dominated by industries such as automobiles, telecommunications, chemicals, and machinery.
The end of World War II marked a golden transformation in the US. During this period, US experienced a tremendous rise in productivity and economic activity. Since then, US GDP has grown at a rate of 4% annually. The industrial and manufacturing sectors never gained full momentum until the 1970s when the economy suffered stagnation in growth characterized by high levels of inflation (Walton & Rockoff, 2014). In response, the government formulated subsequent economic policies with the main aim of reducing government regulation and spending. The policies restored the economic glory, but incurred hefty government’s debts. In the 1990s, new technologies and adoption of IT-oriented productivity led to the birth of high-tech companies which fuelled an economic boom. In fact, the period between 1993 and 2001 marked the largest expansion; the US has ever experienced (Walton & Rockoff, 2014). Internet-based firms wildly drove the stock market until the beginning of 2000 when the “dot-com bubble” had a burst.
The period was also characterized with corporate scandals that deteriorated the economic progress. Needless to mention the negative impacts created by the terrorist attack on 11 September 2001. Nevertheless, the US continued to seek economic improvements. A series of factors that challenged the US at the time included excessive unregulated mortgage lending, low-interest rates, lenient government regulations, high risk taking in the financial market, and excessive consumer indebtedness. The combination of these factors contributed to the global economic crisis that began in 2007 (Walton & Rockoff, 2014). The housing market faced an outright downshift while major banks hit a deadlock. However, the US embarked on a journey to revive the economy through the purchase of mortgage-related assets and floundered distinguished corporations. The government sets aside a stimulus package of over 800 billion US dollars meant to boost economic growth for the following ten years.
Monetary and Government Policies
Fiscal policy is when the government spending is used to increase or reduce the economic growth. The policy influences changes in income, prices, and interest rates. When taxes are lowered, people or businesses experience an increase in income leading to increased demand for goods and services (Arseneau, Chahrour, Chugh & Finkelstein Shapiro, 2015). It also results in higher imports, meaning that citizens will buy more foreign currencies thus decreasing currency exchange. However, this causes high prices of products in the future. Fiscal policy can either be expansionary or contractionary. Expansionary fiscal policies occur when a government wants to grow the economy and reduce taxes. Contractionary is the vice versa when the government wants to control unregulated expansion in consumption and other factors in the economy. Expansionary approaches increase interest rates since the government sells securities. High-interest rates spur an influx in foreign currencies thus attracting investors. On the other hand, contractionary policy causes an opposite effect since low-interest rates mean low return and exchange rates.
Monetary policy changes credit availability and money supply. Similarly, it affects exchange rates in terms of income, prices, and interest rates. The concept is still the same in expansionary and contractionary mechanisms. When the supply of money is high, and the credit is available with ease, individuals and businesses have more money translating to high demand for goods and services. Therefore, when the Federal Reserve wants to expand or shrink an economy, it increases or decreases the money supply, which affects credit availability through a higher rate of interests. Changes in money supply and credit availability influence the foreign currencies and exchange rates. Consequently, investment raises or reduces depending on the resultant exchange rates.
Trade Deficit or Surplus
When domestic producers sell fewer products to foreign consumers while the foreign manufacturers sell more to domestic consumers, it results in a trade deficit. However, when a country exports more and imports less, it results in a trade surplus. The important issue is the maintenance of a balance of trade in the best interests of a country. However, trade deficit or surplus is not necessarily significant given that studies posit that trade imbalances hardly exist over the long term (Batra & Beladi, 2013). Again, even if they did, they would not only cause negative consequences. The fact is that even in a trade deficit, a country still benefits from the currency assets. For example, if the US had a $ 300 trade deficit with Switzerland because its citizens prefer Switzerland watches to American watches, the payment would be made in dollars. Even though GDP would decline, since the payment was made in dollars, it will soon return to America in the form of dollar assets. Hence, as long as the exchange rates are swiftly floating, trade imbalances do not substantially threaten an economy. Nevertheless, the maintenance of trade surplus is essential because it is a component of productivity and GDP. The problem with GDP is that it focuses solely on finished goods and services in an economy unmindful of how efficient an economy is in producing goods or services. As such, that is why promoting trade surplus is important because it is one way of ensuring efficiency in production.
Market for Loanable Funds and Foreign Currency Exchange
These markets symbolize the financial system, where savers enter the market for loanable funds to deposit their savings. People seeking loans to spend or invest also join this market. Savings from government accounts or private sector reflect national savings and implicate the overall economy. One point of the market supplies savings, while the other side uses the money for federal and net foreign investments. Consequently, the equation of savings quantity with the investments procreates the real interest rate (Gómez, Murcia & Zamudio, 2014). The market for loanable funds determines the return one would get for lending his/her money. It influences the savings and demand for money thus governing the real interest rate.
The market for foreign currency exchange is the platform in which the interchange between domestic and foreign currencies occurs. The market is determined by trade deficit or trade surplus. In the case of a trade surplus, the extra foreign currency the economy receives is used to purchase assets abroad, and it is an indication that domestic capital is flowing out. As such, this increases the supply of domestic currencies in foreign nations. On the flip side, a trade deficit means that the economy is experiencing an inflow of foreign capital, which increases the demand for domestic currencies for foreign consumers must exchange their currency to buy a domestic good or service.
Recommendations
Although the US economy is robust and emulated by many countries, the prospects may derail this economic progress given its current path of a budget. The American spending and debt are alarmingly high. Even worse, the future spending and debt are estimated to increase further. Economic studies have it that developed economies like the US risk a prolonged reduction in economic growth when spending and debt are extremely high, particularly reaching 90% of the GDP (Mun, 2014). In 2013, public debt accounted for over 70% of the country’s GDP. Japan and Greece saw a fiscal crisis following intense spending and increased debt, and the two states suffered immense economic stagnation. Hefty public debt fosters avenues that would see interest rates reduce private investment, cause crowding out and a rise in the inflation rate. Hence, today America is condoning an environment capable of sprouting such undermining implications. The poor, elderly and middle class would suffer the most. The federal should devise strategies of cutting its debt to eliminate the probability of a fiscal crisis.
A fiscal crisis reflects poor management of the budget by the government. Investors lose faith with this kind of government and are regularly driven away. Cutting spending and debt will not only cultivate fast economic growth, but also strengthened the US ability to react to unexpected challenges. It is also advisable to delve into debates that surface the need to reduce federal spending in the long-run. As such, this will promote the introduction of a more promising statutory debt ceiling. The country should also reform its national entitlement programs in a bid to minimize debt buildup and avoid unprecedented harmful consequences. The major programs exploiting the federal budget are Social Security and Medicare. Apparently, the programs are unsustainable over a long-term. The programs cost over 40% of the US budget, and it is even questionable if the country can sustain them over a medium term (Chiang & Chen, 2016). The US can cut spending in such programs by increasing age eligibility and phasing out benefits for retirees who had upper-income. The fact is that the US is moving closer to damaging debt levels, and it is a time the country introduces policies that will help in escaping this projected danger.
References
Arseneau, D. M., Chahrour, R., Chugh, S. K., & Finkelstein Shapiro, A. (2015). Optimal Fiscal and Monetary Policy in Customer Markets. Journal Of Money, Credit & Banking (Wiley-Blackwell), 47(4), 617-672. doi:10.1111/jmcb.12223
Batra, R., & Beladi, H. (2013). The US Trade Deficit and the Rate of Interest. Review Of International Economics, 21(4), 614-626. doi:10.1111/roie.12059
Chiang, T. C., & Chen, X. (2016). Stock returns and economic fundamentals in an emerging market: An empirical investigation of domestic and global market forces. International Review Of Economics And Finance, 43107-120. doi:10.1016/j.iref.2015.10.034
Gómez, E., Murcia, A., & Zamudio, N. (2014). Foreign Debt Flows and the Credit Market: A Principal Agent Approach. Ensayos Sobre Política Económica, 3287-103. doi:10.1016/S0120-4483(14)70021-1
Jin, H., Choi, Y., & Kwan Choi, E. (2016). Unemployment and optimal currency intervention in an open economy. International Review Of Economics And Finance, 41253-261. doi:10.1016/j.iref.2015.08.008
Mun, K. (2014). The joint response of stock and foreign exchange markets to macroeconomic surprises: Using US and Japanese data. Journal Of Banking And Finance, 36383-394. doi:10.1016/j.jbankfin.2011.07.014
Walton, G. M., & Rockoff, H. (2014). History of the American economy. Cengage Learning. New York.
