ECO 202 Final Project PDF

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The final/only project for Macroeconomics....

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Josie Yurich ECO 202 Project Template Economic Summary Report

Table of Contents 1. 2. 3. 4. 5. 6. 7.

Introduction Fiscal Policies: Taxation Fiscal Policies: Government Expenditure Monetary Policies Global Context Conclusions References Introduction

For the benefit of the incoming administration, I submit this report to document, analyze, and interpret the macroeconomic policy decisions I made as the chief economic policy advisor of Econland. The purpose of this document is to further our national prosperity by deepening our understanding of the relationship between macroeconomic policies and their consequences for our citizens. The report includes a thorough accounting of the major fiscal and monetary policy decisions made over each of the seven years of my term, as well as an explanation of the underlying rationales for those decisions and the resulting impacts of those policies.

Table 1.1 The table above summarizes the macroeconomic climate of Econland over my term. Throughout my term the population was satisfied with the economy and the policy decisions that I made. I had an average approval rating of 81 points when my term had ended, in which I chose the rollercoaster scenario. Fiscal Policy: Taxation

Table 2.1 When taxes are too high, GDP may shrink, and when taxes are too low, GDP may not shrink, but it may not grow. With this in mind, I decided to decrease the income tax and corporate tax ever so slightly during my term, straying only 5% in the seven years. My reason for decreasing the tax rates were to promote consumption and investment. When the government lowers income tax, it increases the amount the household may take home which the household will then save a portion of, and spend a portion on consumer goods (Mankiw, 2021). Additionally, when corporate taxes decrease, businesses are encouraged to produce more goods and services (Wolfe, 2019). In my term, consumption increased drastically, starting off at 55.0 and ending at a near double of 99.0. The income tax rate had fluctuated beginning in year four, meaning I had constantly adjusted it. Even after the constant change, consumption still continued to rise, while on the other hand investment weakened at this point. Investment had minor increases from the start of my term to year four, when it then stayed the same for one year (five), decreased the next (year six), and finally in year seven saw the most drastic increase during my whole term. The largest increase

had been from year one to year two when investment went up 1.1 points, until the jump from year six to year seven when it increased by 1.3 points. Year five was the year I raised taxes, and it is proven in the economy’s lack of investment that taxes are best when remained at a constant level. According to Jared Walczak (2020) of the time following the Great Recession, “By 2010, general sales taxes were down 8 percent from their 2008 peak, while individual income taxes fell 16 percent and corporate income tax collections plummeted a full 25 percent.” “The Great Recession of 2008/2009 was characterized by the most severe year over year decline in consumption since 1945” (De Nardi et al., 2011, p 2). Though this may not be the most apt example, tax rates being lowered had a positive effect in the long run on consumption but in the short run the economic devastation was too extreme to make any positive changes. During my term I kept tax rates decreasing at a steadily enough level to not cause harm to the economy while still encouraging consumption and investment. Through this example of tax rates and their affect on the economy, I can see how what I did during my term was efficient.

Fiscal Policy: Government Expenditure

Figure 3.1

Figure 3.2 As we know, the government spending rate needs to be adjusted accordingly with income tax, corporate tax, and interest rates. Because I had chosen to lower the tax rates, it meant I needed to increase the government spending to keep a balanced budget. I realized slowly adjusting the budget was best, keeping it between $30 billion and $33 billion. An increase in government purchases stimulates aggregate demand, however this increase may also cause a rise in interest rates which reduces investment spending and puts downward pressure on the aggregate demand, which is referred to as the crowding-out effect (Mankiw, 2021). Too much of an increase too quickly is what may cause this and in making the slight adjustments that I did, the economy did not experience this effect. Much like the other macroeconomic factors, government spending is an important part of GDP. Real GDP growth was high for half of my term, the highest being year seven at about 5%. Though the real GDP may not have been substantially high, it continued to increase throughout my term. The natural level of unemployment is 5% and during my term I did not stray far from that number. The highest level of unemployment that my economy saw was 5.6% in year one, and then 5.3% in years five and six. The rest of my term unemployment stayed lower than its natural level. This is because the increase in GDP caused for an increase in aggregate supply which causes for an increase in the demand for workers. This means that when the aggregate supply in an economy increases, unemployment will decrease (Tutorsonnet, n.d.). Overall, my fiscal policies in both taxation and government spending influenced economic growth through a constant increase in real GDP, low levels of unemployment, and increases in investment and consumption.

Monetary Policies

Figure 4.1 Throughout my term I made the decision to increase the interest rate to encourage saving. In an open economy, when saving is greater than investment this creates a trade surplus because the net capital outflow becomes positive (Mankiw, 2021). I only increased the interest rate up to 3.5% but it did increase my imports and exports significantly, even after I had lowered it back down to 2.5% by year seven. Consumption had also steadily increased throughout my term from 55 to 99, and investment

increased as well, until I decided to bring the interest rate back down. I brought the rate down to 3% for year five because inflation had gone up to 3.7% in year four and I knew this needed to be lower. Overall, the decisions I made concerning the interest rate positively effected the economy, both constantly increasing in nominal GDP and real GDP throughout my term. The federal funds rate, the rate that banks pay for overnight borrowing, is the primary tool the Federal Reserve uses to conduct monetary policy (Federal Reserve, 2020). During the Great Recession of 2007-2009, the U.S. economy weakened extraordinarily in the second half of 2008 because of the increasing instability in financial markets and the declining value of assets. “By the middle of [2008], the FOMC had lowered the federal funds rate 325 basis points. And as indications of economic weakness proliferated and the financial turbulence intensified in the second half, the FOMC continued to ease monetary policy aggressively”, (Federal Reserve, 2009). As inflation continued to rise and the value of items diminished, the Federal Reserve continued easing the monetary policy, the only problem being that monetary policy takes time to kick in. Although the situations differ greatly, when I had noticed inflation rising in my economy, I acted by also lowering interest rates. Because I was not adjusting rates quarterly as the Fed does, I saw the changes I made in year five more so affect the economy in year seven. This does prove to me that while monetary policy is effective at improving economic conditions, it takes time for the change to become positive. Global Context Saving and investment are essential to a nation’s economic growth in the long run. Beings that in a closed economy saving and investment are always equal because there are no imports or exports, instinctually we know that a closed economy is not going to be fruitful in the long run. The components of GDP in an open economy are consumption, investment, government spending, and net exports whereas a closed economy negates the latter. The monetary and fiscal policies will differ in these two economies because of the difference in trade. In the long run, fiscal policy influences saving, investment, and growth in the long run (Mankiw, 2021). In the short run, fiscal policy is more influential on the aggregate demand for goods and services (Mankiw, 2021), and because saving and investment are always equal in closed economies, the fiscal policy will have little influence, if any, in the long run. Because monetary policy controls the interest rate, any change in this rate will cause for change in exchange rates as well, in turn leading to changes in net exports (Saylor Academy, n.d.). Monetary policy does not have as much influence in a closed economy because there is no international trade to be affected by a change in interest rates. Conclusions Macroeconomics studies the entire economic system of a nation- demand and supply, national income, price level, total employment, and savings and investments. On top of that, the causes in fluctuation of these aspects are also studied to understand the reasons and to guarantee maximum income and employment in a nation. Macroeconomics is incredibly significant to any economy to maintain these aspects. In my run as economic advisor for Econland, I feel I made sound policy decisions for a few reasons. The GDP of my economy, both real and nominal, steadily increased throughout my term; the unemployment rate did not stray far from its natural level of 5%; and the economy did not go into a recession. Because I was aiming for low inflation, I knew the trade-off would be a higher level of unemployment as per the Short-run Phillips Curve, and that is evident in Table 1.1. My goal was to create economic growth and through my decisions I believe I did just that. The consumer confidence during my run was steady for the first three years, but unfortunately year four had presented a few challenges. In this year, the consumer confidence dropped, and it

continued to do so until year seven when it spiked from 96.7 to 101.4. As I saw that number continuously decreasing, I made, what I felt, were sound policy decisions to try to reverse the damage. Consumer sentiment is important because confidence in their futures causes more spending, whereas a lack thereof means saving which may cause an economic slowdown (Kuepper, 2019). In the United States economy, consumer spending equates to about 70% of GDP, so consumer confidence is important when making macroeconomic decisions in any economy because the higher the confidence, the more economic growth. References Mankiw, N. G. (2021). Principles of economics (9th ed.). Cengage Learning. Saylor Academy. (n.d.). Monetary policy in the open economy. Retrieved from https://saylordotorg.github.io/text_macroeconomics-theory-through-applications/s14-04-monetarypolicy-in-the-open-ec.html Kuepper, J. (2019). Consumer confidence and its impact on the markets. The Balance. Retrieved from https://www.thebalance.com/consumer-confidence-and-its-impact-on-the-markets-1978947 Board of Governors of the Federal Reserve System. (2020). How does the Federal Reserve affect inflation and employment?. Retrieved from https://www.federalreserve.gov/faqs/money_12856.htm#:~:text=Monetary%20policy%20also%20has %20an%20important%20influence%20on,workers%20and%20materials%20that%20are%20necessary %20for%20production. Board of Governors of the Federal Reserve System. (2009). Monetary policy report to Congress. Retrieved from https://www.federalreserve.gov/monetarypolicy/mpr_20090224_part4.htm Wolfe, M. (2019). What are the benefits of lowering taxes?. Bizfluent. Retrieved from https://bizfluent.com/about-7283858-benefits-lowering-taxes-.html Walczak, J. (2020). Income taxes are more volatile than sales tax during an economic contraction. Tax Foundation. Retrieved from https://taxfoundation.org/income-taxes-are-more-volatile-than-sales-taxesduring-recession/ De Nardi, M., French, E. & Benson, D. (2011). Consumption and the great recession. National Bureau of Economic Research. Retrieved from https://www.nber.org/system/files/working_papers/w17688/w17688.pdf TutorsOnNet. (n.d.). Unemployment- aggregate demand supply. Retrieved from https://www.tutorsonnet.com/unemployment-aggregate-demand-supply-homeworkhelp.php#:~:text=Unemployment%20-%20Aggregate%20Demand%20and%20Aggregate%20Supply: %20Aggregate,and%20expenditure%20relating%20to%20investment,%20government%20and %20consumption....