Factors affecting GDP
Gross Domestic Product of nation measures the monetary values of final goods and services produced within the nation. The main four components of GDP include consumption spending, investment spending, and government spending and net export (Heijdra, 2017). Factors causing change in these components result in a change in GDP of a nation.
An Economic growth in US in the second quarter of ongoing year has recorded an increase mainly due to an increase in consumption spending. Consumption spending in US accounts over two third of total economic activity. The increase in consumption spending is reflected in an increase in retail sales. Federal Reserve adjusts monetary policy according to economic growth. In times of weak economic growth, Fed takes an expansionary policy and reduce interest rate. A contractionary monetary policy is welcomed during rapid expansion of the economy (Uribe & Schmitt-Grohé, 2017). The contractionary monetary policy can be taken in form of a decline in interest rate. Due to strong economic growth resulted from growth in spending and retail sales Fed increased the interest rate, projecting two more further increase in interest by the end of this year. Another factor that encourages Fed to raise interest rate is the falling value of US dollar in the international market. The economic growth of US is still under the threat of a trade tension and retaliatory tariff between US and China.
Summary
After period of worries regarding declining prices, the economy of US again is threatened from an inflationary pressure. Producer price index, reflecting the prices paid by businesses jumped to 3.4 percent earlier this year. Overall cost has been pushed up following increasing cost of transportation and warehouse servicing. The largest increase in price has been observed in trucking freight. This is partly due to an increase in cost of fuel and labor. Higher producer price index does not necessarily mean a higher consumer prices. The economists however expect an increase in headline CPI by to 2.9 percent (theepochtimes.com, 2018). This is the largest gain in prices in the past six years. Strong economic growth in combination with a higher input cost results in an increase in inflation.
Inflation is defined as a sustained increase in the average price level. The average prices of all goods and services together constitutes price level. Inflation is mainly caused either due to an increase in demand or due to an increase in cost (Mankiw, 2014). The resulted inflation from increased demand is called demand-pull inflation while resulted inflation from increased production cost is called cost-push inflation.
The noticeable increase in price level resulted both from an increases in demand and rise in input cost. Production cost has been increased due to an increase in cost of fuel and labor cost. When cost of production increases firms are unable to purchase input in similar quantity due to cost constraint. This in turn reduces available supply of goods and services. With demand remaining unchanged, price goes up following a shortage of goods and services (Heijdra, 2017). Aggregate demand in the economy has increased due to a strong economic growth. The increase in consumer spending causes demand-pull inflation in United State. Imposed tariff often raises average price by raising the price of imported goods. Fed however has denied to accept tariff as a major reason behind inflation. Fed has considered the import tariff to be too small to cause an increase in rate of inflation.
Increase in Consumption Spending
Summary
Rate of unemployment in US is reaching to half-century low. New job opportunities have been created for unemployed workers. The rate of job openings exceeds the number of unemployed workers. This is expected to provide a better condition for the labor force. Wage however does not get any better. With a modest rate of inflation and slow wage growth real hourly wage has declined as compared to that in May 2017. A number of explanation have been put forward for the perceived slow wage growth. With growing automation, demand for manual labor has decreased causing wages to fall (nymag.com, 2018). Therefore, despite increase in job opportunities conditions of workers does not improve in a satisfactory way.
Unemployment is described as a phenomenon where workers are incapable of finding new jobs despite having willingness to do so. Rate of unemployment shows the percentage of unemployed people within the total labor force (Mankiw, 2014).
Currently, the US economy has ample of jobs even exceeding number of people actively looking for jobs. The job opening however fail to improve state of the labor market due to slow growth in wages. More than 15 percent workers in the labor force earn even less than fifty percent of the median wage. Wage in the labor market is determined from active demand and availability of workers. Changes in demand and supply of workers causes equilibrium wage in the labor market to change. With growing automation, demand for manual labor decreases. This in turn reduces the market value of the skills of existing labor force. The excess supply of labor causes wages to fall. Producers are unwilling to hire workers due to slow growth in productivity. The productivity growth has been slowed down due to lack of technological innovation. This type of unemployment caused by a mismatch of skills between skills of available workers and required skills of a particular job is known as structural unemployment (Uribe & Schmitt-Grohé, 2017).
Source
Consumer spending in United State increased more than that expected in April. This gives a positive signal for the economy. However, concern in the economy remains, as people tend to save less. Personal expenditure increase by 0.6 percent as against the forecast of 0.3 percent. Spending is growing even more than income. Personal income has grown only at a rate of 0.3 percent. Saving rate in the economy decreased to 2.8%. This is the third time since the financial crisis in 2008 that saving rate went below 3% (money.cnn.com, 2018). Before the financial crisis rate of saving was below 3% in most of times. However, failure of both stock and housing market, household tend to save more in banks giving a boost to national saving rate.
In order to achieve sustained economic growth, steady investment is required. Investment is financed by saving. Higher saving increases investment, which helps to boost standard of living. National saving in an economy is defined as the sum of private and public saving. Private saving is obtained as household income less taxes less consumption spending. Public saving estimated as a difference between tax and government expenditures.
Monetary Policy
In US, despite increase in consumption spending, low saving tends to threat economic growth. Economic growth based on consumption expenditure cannot be sustained in the long-run. Growth in consumption spending exceeds that of growth in income indicating dissaving in the economy (Van den Berg, 2016). This likely to increase debt burden inhibiting future growth. The overall debt in US now estimated to be $536 billion higher above the last peak of $12.3 trillion during the second quarter of 2008. A significant portion of debt is tied to mortgage payment. The relatively low interest rate encourages people to purchase more homes (Van den Berg, 2016). Saving rate fell to 2.80 this year from 11% in 2012. The declining saving rate causes a decline in investment. An expansionary monetary policy is recommended to avoid the current situation of excess debt. Fed should increase the interest rate to encourage saving.
Source
Summary
US economy is currently focusing on cool down the increases in aggregate expenditure. In order to do Fed adapts the strategy to raise the interest rate. This indicates the economy of US is now on a cool ground. Fed has decided to raise the interest rate or the federal fund rate by 2 basis point setting the targeted rate between 1.75 and 2.00 (sundaytimes.lk, 2018). Fund rate is an important monetary tool used by Fed to control money supply in the economy. In the past three years, Fed is continuously raising the fund rate. Changes in fund rate affects other interest rate in the economy.
Analysis
Planned aggregate expenditure is defined as total planned spending on final goods and services. The planned aggregate expenditure has four components- Consumption, Investment, Government purchase and net export. Aggregate expenditure in an economy changes with change in any of the four principle components of aggregate expenditures.
Interest rate is considered as one important component of aggregate expenditure. It affects aggregate expenditure through affecting investment. An inverse relation exists between investment and interest rate (Balakrishnan, 2018). Federal Reserve adjusts interest rate to control monetary shock in United State. The interest rate that Fed applies to lending on other banks in the economy is known as fund rate. In the past three years, Fed has taken contractionary monetary policy by reducing overall fund rate. A low interest rate makes available credit cheap. The cheap credit encourages borrowing which led to an increase in spending and investment (Mankiw, N. G. (2014). Aggregate spending in the US economy has already exceeded beyond the level that the economy is able to finance reflecting a situation of over-heating. The economy not only need to check this over-heating but also change the habit of over-eating. Hence, policy has been taken to cool down the economy to maintain a healthy growth along with a moderate inflationary pressure.
Conclusion
From the discussion of the chosen articles, a conclusion can be drawn regarding the current state of US economy. The economy is currently experiencing an economic expansion resulted from increase in retail sales. Retail sales have been increased due to boost in consumption spending. The increased consumption spending is also reflected in terms of an increasing inflationary pressure. In spite of having enough job opportunities, the labor market is experiencing a difficult time due to slow wage growth. Another concerning factor for the economy is a decline in saving rate. Saving rate fell to a considerably low level. At present, the economy is in a phase of business cycle expansion. The aggregate expenditure has increased beyond the capacity of the economy leaving the economy over heated. Fed therefore has taken the policy to raise the interest rate to control expenditure and boost the saving rate.
Reference list
Balakrishnan, P. (2018). Macroeconomics in The Economy. Economic & Political Weekly, 53(24), 33.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Inflation in the News, but What Is It Exactly?. (2018). Retrieved from https://www.theepochtimes.com/inflation-in-the-news-but-what-is-it-exactly_2593089.html
Levitz, E. (2018). New Study Confirms That American Workers Are Getting Ripped Off. Retrieved from https://nymag.com/daily/intelligencer/2018/07/oecd-study-labor-conditions-confirms-that-u-s-workers-are-getting-ripped-off.html
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Monica, P. (2018). Consumers are spending a lot more and saving a lot less. Retrieved from https://money.cnn.com/2018/05/31/investing/consumer-spending-savings-rate/index.html
Strong U.S. retail sales lift second-quarter GDP estimates. (2018). Retrieved from https://www.reuters.com/article/us-usa-economy/strong-us-retail-sales-lift-second-quarter-gdp-estimates-idUSKBN1K61KV
Uribe, M., & Schmitt-Grohé, S. (2017). Open economy macroeconomics. Princeton University Press.
US-China trade war: “Cool ground” and “hot ground”. (2018). Retrieved from https://www.sundaytimes.lk/180701/business-times/us-china-trade-war-cool-ground-and-hot-ground-300050.html
Van den Berg, H. (2016). International Finance and Open-Economy Macroeconomics: Theory, History. World Scientific Publishing Company.
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