Alan Greenspan's Testimony Term Paper

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[. . .] Many of the issues discussed and predicted in both reports have come true nowadays in late 2004 and the beginning of 2005. Indeed, the U.S. fiscal and current account deficits have grown lower than any time in history. In order to counterbalance any form of inflationary pressures, the Federal Reserve began to gradually increase the interest rate, reaching 2.5% in February 2005. The dollar, after a record 1.366 against the euro in December 2004 has gained some ground due to the interest rate differential between the U.S. And Europe.

The CBO forecast for 2005 to 2015

reflects in many ways some of the things that have been previously discussed. First of all, we need to look at the real GDP percentage change as the best indicator of how an economy is performing. Estimated at 4.4% in 2004, the U.S. economy will maintain relatively high values of up to 3.7-3.8 up to 2008. This obviously follows the classic theory of economic cycles and may be characterized as a period of consistent economic growth. Of course, in many ways, these are also a reflection of the fiscal and monetary policies that have been applied in Geroge W. Bush's first mandate as president (tax cuts most notably) and the subsequent policies in his second term (a more austere budget was announced in order to fight the budget deficit).

After 2008, the U.S. economy will probably enter a period of cyclical recession, with economic growth of up to only 2.5% in 2015. This is not necessarily a decline, but rather a temporary cooling off in the growth process, necessary in any healthy economy in order to be sustainable.

Surprisingly enough, the consumer price index, the best indicator for any inflationary pressures and counted at 2.7% in 2004, remains constant over a long period of time at 2.2%, from 2008 to 2015. It shouldn't surprise us that it remains at moderate levels: in periods of slight economic recession we will expect inflation to grow because the economy is not produced new jobs and, subsequently, aggregate demand will likely decrease. However, the differences in the index from 2004 to 2015 seem rather small, but this could be an excellent indication of the fact that the monetary policies applied in the first years of the new century, more notably the gradually increase in the interest rate in 2003 and 2004, may have paid off.

The Sinai estimates are quite accurate and relevant, given the fact that we actually know some of the figures that were announced in February 2005 (most notably the current account deficit for December 2004). I want to refer to two important indicators, given the discussion presented so far. First of all, the consumer price index, which will be announced on the 18th of February. Given the -0.7% decrease in December 2004, Sinai estimates a 0.4% increase in January 2005. Economically speaking, the increase in January 2005 is not really justifiable. The main argument in this sense is, again, the interest rate, which has risen up to 2.5%, at moderate 0.25 increase steps. We may argue that, given the fact that the consumer price index decrease by 0.7 in December 2004, a subsequent moderate decrease should also be expected in January 2005, corroborated with the increase in the interest rate.

The second important indicator that is estimated was the trade balance. The actual result was $56.4 billion, somewhat lower than the estimated figure. In my opinion, the trade deficit is actually one of the most difficult indicators to be estimated. According to Bloomberg experts, everybody expected the trade deficit in November to be lower. Instead, it swirled up to over $60 billion. However, the decrease for December is again suited to everything discussed previously. The pressure on the dollar and the lower exchange rate from 2001 to 2004 led to an export boost. Producers worked with a cheaper dollar, while selling abroad for more expensive yen or euro.

3. Everybody seems to be concerned about the U.S. trade and budget deficit, from the president to currency investors. The most important thing we need to decide upon is whether the current U.S. budget and trade deficit are SUSTAINABLE.

Some of the investors have believed that these are not sustainable, that the economy is not growing at a fast enough rate in order to cover the high deficits. Accordingly, they turned away from American assets and have decided to choose the less profitable, but less worrying Europe as a place for business. All this had clear repercussions in the exchange rates. The demand for the dollar dropped dramatically in November and December 2004 to an all time low of 1.366 against the euro. There were other factors that led to a growing demand for the euro, including the announcement of several states (more notably Russia) that they have decided to change some of the dollar reserves into euro. At this point, the prognosis showed an exchange rate of 1.4 or 1.5 at the end of the first trimester in 2005. Again, all these were caused by the fact that the U.S. trade and budget deficits caused serious concerns worldwide.

On the other hand, in 2005, the dollar gradually recovered some of the steps it has lost against the yen and the euro. There were several reasons for this. First of all, President Bush announced that he was determined to reduce the deficits and announced measures in this sense in the budget proposals. Further more, Alan Greenspan announced publicly that the interest rates will continue to grow at a moderate pace in order to remove any inflationary pressures that may appear.

The increase in interest rates meant that an interest differential was created as compared to the Euro zone and that some of the investors began to regain confidence in the U.S. economy. In my opinion, the U.S. economy is much too powerful not to be able to sustain even the massive deficits it has now. Further more, there are clear signs that the economy has recovered from the period of recession and that it is likely to grow with 3.5 -- 3.8% in 2005. If we compare this to modest figures in Europe (probably around 1.5%) and Japan, we are more likely to believe that the dollar will regain lost ground and that investors will choose the United States in 2005 as an investment base. This should likely reduce trade and fiscal deficits.

4. The IS/LM analysis perhaps is best to explain the monetary and fiscal issues we have previously referred to. The IS curve best explains the governmental deficit we have referred to. Given the fact that the Y-axis represent the Gross Domestic Product (GDP) and the X-axis represent the interest rates. The IS curve shows that an increased deficit will most likely shift the IS curve to the right and will increase interest rates, but, at the same time, the GDP.

Obviously, the budget deficit is caused by the expansive fiscal policy I have previously presented, most notably tax cuts and governmental spending. Such a fiscal policy will give way to investments and an increase in overall production. This leads to an increase in overall GDP. On the other hand, a coming economy, stimulated by the expansive fiscal policy, gives way to an increase in the number of jobs and, as a direct result, there is an extra incentive to individual consumption, which may give rise to inflationary pressures. As a direct consequence, the interest rates will be adjusted in order to cope with the new equilibrium level that is thus formed.

The LM curve is directly linked with aggregate supply and demand on the monetary market and the aggregate supply and demand analysis comes in handy as well now. An increase in the money supply shifts the LM curve to the right and, as such, interest rates decrease. On the other hand, an increase in aggregate demand for money acts as a pressure factor on the interest rates, which will rise as well.

The IS/LM model and the aggregate supply and demand analysis come only to further prove some of the aspects discussed previously. Indeed, the model is best to explain the intrinsic link between the fiscal policy (more notably, expansive fiscal policy), the demand / for/of money on the money market and the relationship with the monetary policy. The link between the two should be seen as being, in my opinion, the interest rate leverage. On the monetary field, the interest rate will closely follow up on any excess of money on the market and will temper inflationary pressures that may arise due to excessive money on the market. On the other hand, the interest rates have a fiscal policy: as we have seen from the IS analysis, an expansive fiscal policy a move of the curve to the west.

5. In order to give some consistent forecasts, we should probably start… [END OF PREVIEW] . . . READ MORE

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Alan Greenspan's Testimony.  (2005, February 11).  Retrieved January 28, 2020, from https://www.essaytown.com/subjects/paper/alan-greenspan-testimony-starts/7853

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