VINAY MARURI – APRIL 9TH, 2018
By all metrics, America is booming: the nationwide unemployment rate is 4.1%, inflation is low, and wages are starting to rise on average for American workers. The Federal Reserve continues to signal to the world that macroeconomic trends will be positive this year and in the near future for the American economy.
However, while the Fed is issuing rosy statements to the International Finance Symposium and to world leaders, behind closed doors, they may be preparing for impending economic troubles. This week, the Fed submitted a report to Congress claiming that asset prices, for stocks and commercial real estate in particular, were higher than their models had predicted. In a later statement, they declared that the economy was past full employment, despite lackluster wage growth. All signs, including recent corrections in the stock market and extreme volatility in the cryptocurrency market, point to an economic contraction coming soon.
In defiance of conventional economic prescriptions at this stage of the business cycle, the United States government are continuing to stimulate the economy in the hopes that they can drive economic growth even higher. While the outcome of this policy is in doubt, it is important to investigate the potential consequences of this action. Other countries, especially Turkey, provide ominous signs for America’s choice of policy. Turkey pursued expansionist fiscal and monetary policy for a decade, which mirrors the policy choices that America has made over the past decade. Both countries started their policies in the midst of recessions and continued them until their economies either overheated or reached the brink of overheating to the point of producing more than their sustainable potential outputs.
In 2016, after 10 years of fiscal and monetary stimulus, Turkey’s economy collapsed spectacularly, falling into a recession. Expansionist monetary policy encouraged businesses to take large loans using artificially low interest rates, while expansionist fiscal policy contributed to creating a high inflation environment. The Turkish government’s low interest rate policy encouraged the Turkish private sector to build up large amounts of debt, and when their ability to pay these debts came into question, the Turkish lira plummeted. This resulted in large current account deficits, credit rating downgrades by Moody’s and Fitch and unemployment increases, as well as a sharp uptick in inflation.
Despite this evidence, the United States federal government continues to push for faster and faster growth. In December 2017, Congress passed tax cuts worth trillions for individuals and businesses, with the intent to promote more economic activity. Now, they are proposing a bill to stimulate the economy more by spending $1.5 trillion on building roads, bridges, and other national infrastructure over the next ten years, which experts forecast will have little to no impact on economic growth and will have an overall inflationary effect, bringing the U.S. economy closer to overheating. Furthermore, citing inflation below their 2% target, the Federal Reserve is still sluggish in raising the Federal Funds rate. They are placing a risky bet that if a recession hits, it will happen far enough in the future that there will be sufficient time to reduce interest rates to stimulate the economy. This ignores the fact that the economy is growing faster than its potential, that the administration is stimulating the economy into an unprecedented expansionary period, and that the economy is being propped up by low interest rates and rising federal spending.
The Federal Reserve and Congress are playing Russian roulette with the American economy. Given what happened to Turkey, federal fiscal and monetary policymakers would be wise to adopt a more cautious approach.
Featured Image Source: The Economist
Disclaimer: The views published in this journal are those of the individual authors or speakers and do not necessarily reflect the position or policy of The Berkeley Economic Review staff, the Undergraduate Economics Association, the UC Berkeley Economics Department and faculty, or the University of California at Berkeley in general.
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