US Economy is a mixed economy where the private sector plays a major role in economic activity and the role of government is minimal compared to other industrialized countries like Great Britain, Germany, France, Spain, Netherlands, Scandinavian Countries and East European countries.
However after the Great depression in1930’s the government at least used monetary and fiscal policy to achieve the macroeconomic objectives of full-employment, price stability
External balance and non-inflationary economic growth. However the reliance on the above macroeconomic policy varied from one administration to the next after world war II as well the orientation towards fiscal and monetary policy to control or stabilize the economy or in other words there is controversy among economist whether the fiscal and monetary policy will actually work in practice and to the extent to its effectiveness in stabilizing the economy or whether these policies may be counter productive to the market economies and the causes of economic cycles and explanation of the causes of the great depression at least among US economist or among economist in general.
However even with these controversies and differing perspectives how the economic variables relate and the differing confidence of market mechanisms to come to equilibrium at full employment if the market is allowed to work without any interference the monetary authorities intervene in the economy to correct market failure and other externalities or for some political and welfare reasons.
In this context it is necessary to consider the effectiveness of these policies in the context of empirical evidence and give due consideration of the structural or institutional framework and the market conditions particularly the labor market conditions in US in goods markets as well as in the financial market structure and workings within the context of global economic interdependencies between economies in the contemporary economic climate as well as how the agents react or form expectation about inflation as well as the political imperatives influencing policy orientation in US.
In macroeconomic policy development in the context of the US political institutional structure and political process as well as the probability of economic shocks and political shocks in other parts and how these affects the occurrence of volatility in economic performance and the current concerns of environmental issues and the cost and benefits and the impact of regulation on the level of economic activity and the rate of economic growth fluctuation and its predictability or uncertainty in forecasting economic outlook for short, medium term .
As well the cost of oil and the political instability in the middle east and how the energy issue is addressed in US by the market mechanism will definitely affect the economic performance in a macroeconomic perspective for US in the future and the importance or other wise of macroeconomic policies or the status of macroeconomics in general as opposed to neoclassical economics or microeconomics foundation or neoclassical monetarist perspectives and less preference to fiscal policies and micro economic reform or supply-side economics and minimal interference by government in the market operation.
The effectiveness of Fiscal and Monetary policy in US
In context of US economic system and the flexibility of markets to responds to changes in demand and supply and other economic information particularly the labor market flexibility in the US compared to other industrialized countries and historically less preference of economic agents for government to be interfere in the market and in its political institutions suggests that rational expectation theory may be mostly applicable to US and there fore the effectiveness of Fiscal and monetary policy may be less effective in US compared to other industrialized countries and microeconomic reform polices and neoclassical monetary theory may be most applicable in the US context.
However the expectation formation in reality is not completely rational and adaptation may also be not rational completely and there fore at least in short term monetary policy may be effective in controlling the rate of inflation in the context of US economy and keep the inflation target at optimum level. In practice the monetary and fiscal policy has time lag to work in practice and there fore if they are used to stabilize the economy because of the time lag it takes to work it may increase the cyclical boom bust pattern of economic development and there fore loose its credibility particularly the discretionary fiscal and monetary policy in reducing unemployment or controlling inflation.
Or it may be achieving low unemployment at a very high rate of inflation or low inflation at a high level of unemployment in the short term and in long term the economy will move towards the original level because of the market incorporates all expectation rationally and moves to the non-accelerated Inflation rate of unemployment (NAIRU) as well flexibility in the labor market to a greater extent because of less stringent regulation of labor market in US compared to say for example Germany or other advanced European economies.
However fiscal, and monetary policy has worked in short term in context of high unemployment at least after the great depression for some time in the 1990’s and still has a role to play at least to control inflation and response to inflationary shocks by monetary policy. In summary given the empirical evidence and the market characteristics of US and the Institutional frame work politically and socially the macroeconomic polices effectiveness suggests in practice to be less effective in US context.
As discussed above in US Macroeconomics is considered at least in terms of its usefulness to some extent achieve its macroeconomic objectives. However the effectiveness of such policies and the controversy among economists in regards to trade –off between economic variables and its relationships in US context reduces its importance and move towards to microeconomic foundations of Says Low or neo macroeconomic foundations and far from Keynesian Economics of fiscal policy particularly the discretionary fiscal policy and deficit financing to reduce unemployment because of market failure.
This to some extent due to Friedman monetary revolution in US and cased doubt about the inflationary outcomes of fiscal policy and crowding out effect and its impact on interest rat and its effect on investment level and there fore not increasing output and employment level but on prices. In addition as discussed above due to the political institutional structure and expectation formation in US the macroeconomic foundations are contentious in US.
In addition the flexibility of labor market and other markets in US suggests that market may work in an opposite direction to nullify the impact of these policies on macro economic variables such as employment level and inflation and increases the adoption of microeconomic reform and supply-side economics to address economic growth, unemployment, price stability and external balance rather than only relying on macroeconomic policies and macroeconomic theories which has many controversies and diverse policy prescriptions to address any macroeconomic objective and the trade-off between these objectives and the relationships between economic variables.
Given the macroeconomic knowledge how an economy works is incomplete and its predicts are far from certain. There foe given the arguments and the discussion it can be said macroeconomics in US has a role to play in formulating polices in the future however given the practical issues of macroeconomic policy effectiveness micro foundations of economy may become important in the future in context of US market conditions and flexibility as well as how expectations are formed and adaptations of expectations in practice and political institutional and political orientation towards a free market perspective.
Brayton. F, Mauskpf. E, Reifschneider. D, Tinsley. P, Williams. J. (1997). The Role of Expectations in FRB/US macroeconomic model. Federal Reserve Bulletin. Retrieved March, 2, 2007, from http://findarticles.com/p/articles/mi_m4126/is_n4_v83/ai_19405190
Federal Reserve Bank of San Francisco. (1997). What is the Optimal Rate of Inflation?. Federal Reserve Bank of San Francisco. Reteived march 2, 2007, from http://www.frbsf.org/econrsrch/wklyltr/el97-27.html
Fiscal and monetary policy – comparisons (n.d). Retrieved March 2, 2007, from http://www.tutor2u.net/economics/content/topics/fiscalpolicy/fiscal_monetary_comparison.htm
Palley. T. (1998). Zero is not the Optimal rate of Inflation. Challenge, 41, 1, Retrieved March 2, 2007, from http://www.questia.com/PM.qst?a=o&d=5001329648
Roach.S. (2006). Global economy, Chinese economic policy, US hosing slump, Money Week. Retrieved March 2, 2007, from http://www.moneyweek.com/file/21503/the-two-key-issues-facing-the-global-economy.html
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