Is the U.S. Headed Towards the Second Great Depression?

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Macroeconomics Indices

Microeconomic indices are the indicators that demonstrate the economic status of a country (Mankiw, 2006). They give a direction as to how the economy would grow in the future. The governments, private investors and other organizations use this information as a key business decision making tool. It gathers historical data that relates to the economy and compares it to current trends. This enables the investor to compile a snapshot of economic fluctuations.

The changes in the economy may affect the direction of an indicator. It may be lagging, coincident or leading (Mankiw, 2006). Lagging indicators remain the same until after the economy has changed, whereas, leading indicators change before the economy has recognized the change. However, coincident indicators move at the time the economy changes.

Example of the coincident indicator is the Gross Domestic Product (Economic About, 2006). Examples of macroeconomic indicators include retail sales, real GDP, inflation rates, unemployment rates, savings rates and housing rates (Mankiw, 2006).

Real Gross Domestic Product (GDP)

Real (GDP) is described as the most comprehensive measure of United States economic performance (Mankiw, 2006). It is mostly used by the Federal Reserve Bank whose duty is to sustain the level of growth with stable prices and full employment. American policy makers are able to evaluate the performance in relation to the banks primary goal. They achieve this objective by monitoring trends in the overall growth rate. Other economic variables like rate of inflation and unemployment are also studied.

The gross domestic product measures services and products that are purchased or sold in the American economy. The National Council of Economic Education (NCEE) confirms changes in the economic sector are of significance. The changes to GDP provide the actual figures of what has happened. It provides a clue as to the qualities of American commodities without any change in the inflation level.

According to the article under review, the U.S.’s GDP would fall by 25% from its current $ 14 trillion to $ 10.5 trillion if the country is to go through a depression similar to that experienced in 1929 (Amadeo, 2011). The U.S has always been ranked fast in economic growth except for the period between early 2008 and late 2009 that there was a negative growth as indicated in the country’s GDP.

This was the first time the real GDP has slacked to a negative since 1993. It is clear that most countries in the world are going through tough times at the moment and it all depends on the economic principles adopted by the U.S. that will save it from such an experience. In this regard, the article indirectly presents the following principle.

A country’s standard of living depends on its ability to produce

Economic growth can be affected by public policy that encourages saving and investment. A higher savings rate can provide funds for loans and investment in capital equipment and the development of new technology for both new business opportunities and for increased productivity. Alternatively, countries with stable political and legal systems can encourage domestic and foreign investment in their countries for increased productivity and wealth creation for local residents.

The current situation in the U.S. is frustrating as outlined by Amadeo in her article. Banks are unwilling to lend money to business people and the same applies to the Federal Reserve that has been hesitant to launch QE3 even after QE2 has expired (Amadeo, 2011). As a solution, Amadeo advices American citizens to invest in education ensuring that they have at least a college degree to be assured of a job in the current economy.

A country’s Gross Domestic product is affected by the government policies that encourage acquisition of education. Educated individuals can apply new knowledge for more efficient production practices. They can also earn higher incomes and start new businesses, which can elevate a country’s GDP. Education has also been found to have an inverse relationship on a country’s birth rates. A smaller population can allow for a higher GDP and less stress on education systems and natural resources.

Similarly, governments also can play a role in the promotion of quality health habits and practices to allow for maximized human contribution and productivity. Finally, to gain the benefits of comparative advantages, governments can act to facilitate free trade.

As we have learned in the past modules, by specializing and leveraging natural resources, countries can incorporate their unique or more efficient practices to gain other goods and services that they are not as efficient in producing. Through comparative advantage and trade, countries can, therefore, enhance their GDP.

Unemployment Rate

This is one of the indicators economists observe to foresee the possibility of the economy diving in to a recession, or is already on the way to recession. It is used to show if the business cycle is in the downward or upward movement in the economic activity. Employment rate is defined as a percentage of people in the economy who are, qualified and willing to work but who are not working (Colander, 2004). It is affected by various economic conditions.

Unemployment rises if the economy is in recession. During expansion, the level of unemployment falls. In the study, there are two notable forms of unemployment to consider. Fluctuation of economic activity leads to cyclical unemployment while elimination of a position that is no longer needed in a company leads to structural Unemployment.

According to Amadeo’s article, approximately 14 million people in the U.S. are currently job seeking and more that 40% of this figure have been seeking employment for the past six months (Amadeo, 2011). Another 8.4 million people in the U.S. are on part time employment because they are not able to find full time jobs (Amadeo, 2011).

Unemployment rate in the U.S. has been on the rise and this raises concern to any economic analyst. As many graduate from universities and colleges yearly to join the job market, where is the economy headed to?

There are various reasons that explain the increase in the unemployment rate in the U.S. Some companies laid off their employees on a temporary basis, or permanently following the 2008-2009 economic recession. Some were as a result of structuring of the company while others were occasioned by companies inability to fund a program.

Most of these factors have a profound impact on the larger economy. This must have definitely increased the number of people fired from jobs and the overall unemployment rate as well. Even before the 2008 economic recession, unemployment rate was already in the rise.

Those fired from their jobs from March 2005 to March 2006, has risen from 2.3% to 2.8% (Congressional Budget Office, 2005). This, therefore, calls for adequate policies to ensure that unemployment rate is checked as it can have a negative impact in the general economy.

If we consider the use of monetary policy in establishing long-run trends while dealing with short-term challenges, we are confronted with one of the classic economic principles between inflation and unemployment. This leads us to Phillips curve as the economic most principle applicable.

The Phillips curve depicts that trade-off between inflation and unemployment in the short-run

Through government policy, expansion or contraction of aggregate demand can impact the inverse relationship between inflation and unemployment. For example, when the Fed reduces growth in the money supply to reduce inflation, it results in higher unemployment in the short-run.

In the long-run, the market adjusts through price reduction, which drives demand and production to increase employment. Economists agree that trade-offs between inflation and employment are not permanent, but they can be tools to deal with unexpected shocks to the economy. What is happening in the U.S. currently as depicted in Amadeo’s article is possibly the Fed’s strategy to curb inflation by reducing lending to the public.

Throughout history, the Fed has attempted to handle short-run economic shocks. In the 1970’s the price of oil dramatically increased. To compensate for the higher level of prices caused by the price of oil, the Fed increased the supply of money which led to higher inflation and higher unemployment.

In the 1980’s with inflation spiraling out of control, the Fed began to remove money from the economy, causing a drop in inflation but a large increase in unemployment. In 2001 with the terrorist attacks, corporate accounting scandals, and the dot-com bust, aggregate demand dropped and unemployment rose.

Under this scenario, the Federal Reserve Bank used expansion monetary and fiscal policies to return unemployment to its natural rate. Faced by the recent worldwide economic collapse attributed to problems in the housing and financial market sector, the U.S’ government reacted by increasing government spending, making transfer payments, and providing large loans to expand the economy.

The worry now, as economic principles foretell, is that inflation is around the corner for the US, therefore, it will depend on the ability of the Fed to make money supply adjustments carefully as it monitors consumer spending and saving and bank lending.

One last, but not insignificant, component of economic well-being is human behavior. The faith or trust that people have in what their governments is expected to do for economic prosperity have an impact on the realization of that belief. If a nation’s government can be trusted to respond in the benefit of its people, the people will accept trade-offs today for future prosperity tomorrow.

Unfortunately, history reflects more errors in judgment than successes in the government’s or the Fed’s ability to make accurate adjustments. Nonetheless, economics show that, despite the short-run fluctuations or trauma experienced in the market, in the long-run, in free economies, natural equilibriums do return as people adjust their behavior and expectations.

Inflation Rate (CPI)

Inflation rate is defined as general and continuous increase in the price level of commodities in the economy. A base price must be established first before determining the actual amount of increase in the price level.

The economists, therefore, require a price index that would enable them measure the level of inflation. Colander² (2004) defines price index as “a number that gives a summary of what would happen to a weighted composite of prices of selected goods” ( p.21).

In Amadeo’s article, price index in measured by oil prices. The high oil price is a clear indication of inflation in her view as the world’s economy rests on oil as its foundation. High oil prices, therefore, will not only affect the U.S. economy, but the world as a whole hence the possibility of a worst depression.

Inflation also takes its roots from economic principle;

Prices rise when the government prints too much money

The concept of money is that it is something people use to represent a store of value that we use regularly to purchase commodities. It functions as a medium of exchange, so that we can trade it for goods and services, and as a unit of account in which economic values and prices are recorded.

The control of the money supply is handled by the Federal Open Market Committee (FOMC). The FOMC is the Fed, but includes just five of the twelve regional Fed bank presidents. Through the decisions made by the FOMC, the Fed can control the money supply.

To increase the money supply, the Fed can print dollars and buy treasury bonds from the public through the New Yolk Stock Exchange markets. Or, if the Fed wants to lower the money supply it sells treasury bonds from its portfolio to the public. Money supply in the economy is reduced through the process. This lessens the strain on the prices of commodities.

Banks themselves can participate in the control of the money supply. They can do so by increasing the reserves and deposits to enact the money multiplier effect. While the Fed controls the required reserve rates of banks, it does not prevent banks for holding more than the required rate nor from reducing the funds that it lends out.

As we have seen in recent times, banks may hold plentiful reserves on deposits yet not lend to the maximum that they could be under Fed regulations. This action, while conservative, may then adversely impact the supply of money, requiring the Fed to put money into the system through other means such as the purchase of bonds.

It also does not have control over how the general population saves or spends or takes out loans on money. Therefore, without perfect control, the Fed cannot fully control the money supply, and that can contribute to short-run fluctuations in the economy.

Housing Starts

This economic indicator provides a track at how many single family buildings or homes are constructed within a month. In the survey, each single apartment or each house is counted as a single housing start. One building that contains 200 apartments is referred to as 200 housing starts. The count incorporates both public and privately owned units. Mobile homes are exempted from this count.

A housing start indicates a measure of residence houses on which construction started each month. Under construction terms, a start is defined as the beginning of excavation as a foundation for the building or house that is meant to be a residence. Most of the data is available from the applications and construction permits for building homes. It is often offered in a seasonally adjusted format and an unadjusted.

The housing starts committee breaks down the monthly national report according to regions: Midwest, Northeast, West and South. During briefing, it is recommended to analyze the regional data. Such recommendation is the high degree of volatility. This level of volatility is normally attributed to the weather changes or natural disasters. A tsunami or floods warning could delay most of the housing starts in the regions.

In Amadeo’s article, the country is currently experiencing low housing prices. While this may be an incentive for U.S. citizens to own houses, the general economy remains at risk. Bank’s risk losing money through bad debts as home owners may find it difficult to pay their mortgages.

Better still, people are obviously reluctant to sell their houses at the current rate or even acquire bank loan for construction. Unless people are assured of better times, banks will be reluctant to fund housing projects and the impact will be worse on housing starts. Housing starts detect trends occurring in the economy as housing starts become the leading indicator.

A declining housing starts exhibit a slowing economy while increases in the housing start activity indicate a growing economy. The close relationship between housing starts and mortgage has a massive impact on the activities of the bond market. It affects the interest rates and the forecasts on its movements. An increase in interest rates leads to a decline in the housing starts.

Conclusion

The above economic indicators, such as unemployment rate, real GDP, housing starts, and inflation rate, are used as measuring tools in monitoring the economy as a whole. These indicators are also used to foretell the future growth of a country’s economy. They also help the governments, investors and other non-governmental organizations make the proper decision and necessary adjustments.

The information can be used to avoid a recession or depression by viewing and understanding the various economic trends. Amadeo’s article provides some insights as to the direction the economy might be headed to if no actions are taken. However, concluding that the U.S. is headed for a great depression could an overstatement of the situation.

References

Amadeo, K. (2011). “Is the U.S. headed towards the second great depression?” Web.

Colander, D. (2004). Economics. Supply and demand: Macroeconomic variables. New York: The McGraw-Hill.

Colander, D. C. (2004). Economic Growth: Business Cycles, Unemployment, and Inflation. New York: The McGraw-Hill.

Congressional Budget Office (2005). The Budget and economic outlook: Fiscal Years 2005-2014. Web.

Economic About (2006). A Beginner’s Guide to Economic Indicators. Web.

Mankiw, N.G. (2006). Principles of macroeconomics (6^th e.d.). New York: Worth Publishers.

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