US Economic Policies during Trade Cycles
Every economic system faces periodic rise and fall of economic activities(output), which we call business or trade cycles. This periodic fluctuation in economic activities can be graphically represented through a stylised business cycle. A Business cycle is studied through features like the cycle’s amplitude (severity of the cycle c+e,e+g) and the duration of the process (the period between any two consecutive troughs or peaks or up crosses or down crosses).
Based on the duration, every economic system undergoes different phases of the business cycle, namely the expansionary phase and the contractionary phase. The term recession describes a slowdown in a contractionary degree, whereas depression represents an extreme recession.
The period of the cycle is the length of time taken to complete a cycle, and it can be studied through the duration between two successive
a)Troughs -Point A and E
b)Peaks -Point C and G
c)Upcrosses — B and F
d) Downcrosses — Point D and H
The phases can also be categorised as expansion, peak, contraction, and trough. Theoretically, there is no consensus on the causes and the means to control the business cycles. Thus, based on the ideologies of the political parties in power, the governments’ fiscal policies change in response to expansionary and contractionary phases. The monetary policies of the central banks are often influenced by the dominant economic views of the era; for example, in the post-2009 period, central banks objectives across the world are defined in terms of achieving price stability and maximum employment.
Theoretically, there are five broad approaches to explain the cause and control of business cycles, namely
a)the Keynesian approach, which explains the fluctuations in economic activity caused by changes in autonomous expenditures. Expansionary and contractionary phases are defined through the interaction of the multiplier process and the accelerator, while ceilings and floors account for turning points in the cycle. To control these fluctuations, the Keynesian approach suggests an interventionist stance by the government through fiscal policy measures as seen in the deficit spending during the covid crisis.
b)The Monetarist approach explains the cause through changes in the rate of monetary growth. Since the credit rate causes economic fluctuations, monetarists advocate that the authorities pursue a financial rule rather than attempt to use monetary policy in a discretionary manner. There are various rules advised to avoid the discretionary monetary policy; Friedman’s power is that the authorities pursue a fixed rate of economic growth in line with the economy’s long-run growth potential. Monetarists adopt a non-interventionist role in the aggregate demand of the economy.
c)The new classical approach argues that fluctuations are caused by unanticipated monetary shocks, which confuse the economic agents leading to variations in output and employment. However, like monetarists, they prefer non-intervention on the demand side of the economy.
d)According to the real business cycle approach, cycles are due to a succession of supply shocks hitting the economy; there is no role for the government to stabilise economic growth rate fluctuations in output and employment through aggregate demand policies.
e)The political business cycle approach suggests that fluctuations in output are caused by the policies of politicians and their expediencies of reelection and survival.
Business Cycles of the USA and Policy responses
During the contractionary phase of the Great depression from August 1929 to March 1933, the US faced a massive liquidity crisis due to the continued increase in interest rates by the Fed. The US economy faced a substantial economic contraction of 12.9% in 1932. In response, the US government introduced a new deal that ended the crisis through fiscal measures. It included 3 R’s as called by historians “Three Rs”: relief (for the unemployed), recovery (of the economy through federal spending and job creation), and. reform (of capitalism, through regulatory legislation and the creation of new social welfare programs).”
Since the end of World War II, economies worldwide began to follow Keynesian policy measures of deficit spending to overcome the recessions during the contractionary phase. Thus, the world economies witnessed continuous economic growth for 20 long years, also called the golden age of capitalism. During the expansionary phase, the governments were able to adjust their deficits with increased public revenue resulting from an increase in economic output.
However, the long expansion came to an abrupt end with the oil embargo of 1972, which coincided with wage control measures brought by Richard Nixon. This resulted in inflation, contraction, and low employment as firms laid off workers due to wage control measures. The economic problem of Stagflation confused the policymakers as the Keynesian approach failed to resolve the crisis. Milton Friedman gave his monetary theory predicting the situation. He argued that inflation is an economic phenomenon, and his ideas on economic policy were used to resolve the crisis by the federal reserve. Since then, the role of central banks in maintaining price stability and inflation has been widely accepted across the world.
The economic expansions from 1945–1981 lasted around three year-end months on average. Since then, the economic developments have become longer and weaker in growth in output.
There have been intermittent recessions and contractions since then due to various reasons such as the East Asian Financial Crisis, the internet boom and the Y2K crisis. Between 2001–2007 was the expansionary phase that reached its slump during the global financial crisis brought by the subprime mortgage crisis. Learning from the great depression, the federal reserve’s pumped liquidity into the economy, and the Obama administration got a sizeable fiscal stimulus measure. The period between the 2008 crisis and the COVID recession is the most extended expansion period in the US economic history lasting for 128 months from the trough of June 2009.
The COVID Recession
In the recent meeting by the economists at the National Bureau of economic research, it was declared that COVID 19 recession, the global recession that brought the COVID Pandemic, is America’s deepest since the great depression and shortest spanning March and April 2020. The rebound in growth rate to 33% in the next quarter was the second-highest in post-war economic history. The recent recession gives many vital lessons to study the business cycles, especially the US economy’s nature.
Unlike the post-war recoveries frbudgetary940–80, the recent rallies are becoming jobless, i.e. recovery in employment is lagging behind the recovery in output. About 22m jobs were lost between February and April 2020, and 16.6m have since been added back. Still, hiring is once again lagging behind GDP. This can be explained by the increase in labour productivity and the disruption caused by automation in various sectors.
Fiscal and Monetary responses to the Covid recession
The Pandemic in the United States led to around 652000 deaths, with the economy plunging in February 2020, and the unemployment rose to 14.7% in April, the highest since the Great depression. The economy quickly rebounded in august 2021 with a 5.2 % unemployment rate and a 3.5% fall in GDP on a year over year basis.
To understand the rebound in the economy, it is vital to break down the fiscal and monetary responses in the US economy. The fiscal policy measures by the congress and president were complemented by the monetary policy measures by the Federal Reserve.
The Monetary response
The response of the Fed was primarily directed to maintain liquidity in the economy and provide support to the businesses from suffering due to the crisis. The stated Monetary policy goals of the Federal reserve are maximum employment and price stability- the Fed would target an average of 2% inflation over the long run while also seeking to let the economy reach full employment. The stimulus measures to increase the output can be categorised into interest rate cuts, loans and asset purchases, and regulation changes.
In interest rates, the Federal Reserve cut its benchmark federal fund rate two times by 0.5% and 1% lowering the federal funds rate to 0.00% to 0.25%.
In Asset Purchases, the Fed has brought four trillion$ in assets during the pandemic ranging from treasuries; mortgage-backed securities and corporate bonds. Under Quantitative easing, the federal reserve brought US treasuries and mortgage-backed securities pumping liquidity to the economy on a dynamic scale and expanding its repo operations by two trillion$.
In loans, the Fed supported lending under the CARES act and set up various special purpose vehicles to lend to different sectors across the industry facing supply shocks and fund crunch. For example, under the Main Street Lending Program, it set up an SPV to purchase up to $600 billion in small- and medium-sized business loans.
Under regulation and policy changes, it made changes in regulations to improve the liquidity in the markets. The responses by the central banks during the recession in 2008 and 2020 should be seen from the lessons drawn from the 1930 crisis.
The Fiscal Response
The fiscal response by the US government was a considerable debt-funded stimulus package brought in various sub-packages throughout the year under Trump and Biden, amounting to 10% of pre-crisis GDP. Under the first stimulus, funds were allocated to vaccine research and development. In the second relief package, the Families First Coronavirus Response Act (FFCRA), or Phase Two, income support was given to families relying on free school lunches and support to covid affected employees and families. In phase three, the most significant fiscal response of 2.3 trillion in US history, also known as the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), was declared by the government; it included a one-time cash payment of $1,200 per person, plus $500 per child were provided along with mortgage forbearance and grants to Schools and NGOs. Other measures later included student loan forbearance and support to minorities.
In March 2021, Biden signed a 1.9 trillion$ American rescue plan giving Direct cash payments of up to $1,400 for individuals earning less than $75,000 a year, plus $1,400 per dependent in the families.
Thus, over the years, the US government and the Federal reserve used a mix of monetary and fiscal policy measures to overcome recession and during the expansionary phases, they followed their broader policy goals, namely price stability and employment for the federal reserve and the political purposes by the respective parties in the government.
