How do the trade deficits, poor economy and bunker-busting budget deficits affect the overall performance in the US economy and the psychic of the consumers? Given sufficient time the economy will recover and show sustainable growth. In the short term, the government has one strong weapon that helps to regulate or stimulate sluggish economy: tax cut may spur growth but it is a temporary measure. The last tax cut was may targeted to benefit the upper one percentile of Americans making $100,000 and over. The other weapon is interest rates. Interest rate is the amount or surcharge the federal bank imposes or charges customers. Low interest rates encourage both the government and private sectors to borrow from banks to do business. The interest rates have decelerated to an all time low (about 5.6%). Since the economy is not doing well, the federal bank has been reluctant to raise the interest rates. The overall result is that it promoted a cascade of effects in the all-economic sectors.
With low interest rates, the home mortgage industry picked up. Homeowners were attracted to refinance because of the low interest rates. Homeowners, the banking industries, financial institutions and all associated businesses experienced increases in growth and productivity. The reduced interest rate also helped to sustain the economy by keeping people employed. In related industries, it meant home improvement materials, increased manufacturing and distribution, sales to countries that need such materials for housing. Reduced interest rates also means that the corporate sector can also borrow money at low rates for retooling, improving machinery, building new factories, and manufacturing merchandise, distributing and sales.
The decreased interest rate in the US means strong borrowing to do business both at home and oversea. Abroad, the improving US economy and strong revenue collection means strong dollar or comparable exchange rates relative to the host countries. It means that the dollar can buy more, trade deficit can be reduced and jobs can be maintained at home. Overall, a reduced interest rate during a period of reduced productivity or no growth, unemployment and fiscal irresponsibility in the government is a panacea for stimulating an ailing economy.
II. Here is another example. Kenya, a developing country has taken measures to stabilize their ailing economy by accepting a three-year US$252.75 million Poverty Reduction and Growth Facility (PRGF) arrangement from the International Monetary Fund (IMF) under a comprehensive Economic Recovery Strategy for Wealth and Employment Creation (ERSWEC) program. Program seeks to lay groundwork for strong economic and employment growth and poverty reduction through a framework for macroeconomics, structural and social policies reforms that promote growth and reduce poverty. The loan is repayable over 10 years with 0.5% interest rate and 5.5-years as grace period.
Kenya’s macroeconomic outcomes prior to receiving the loan have been below expectation in several sectors: economic growth were less than expected, consumer price inflation slowed down among others. The overall fiscal deficit were larger than projected and net domestic financing expanded due to decrease in revenues; domestic debt increased from 19.6 to 25.0% and external current account deficits markedly narrowed due to decreased in investments.
How do a weak economy, consumer price inflation, fiscal deficits and increase in domestic debt among others affect the exchange rate of Kenya? A weak economy suggests that the government will have less money in their treasury to fund domestic and foreign programs and many more. Locally when price inflation is high, consumer pricing goes up and locally produced merchandises decreases and poverty increases. It simply suggests that the monetary system is so weak compared to the dollar or other exchange rates that so much of that currency is required to purchase minimum commodities. In other words, consumer price inflation devaluates the currency of that country. An increase in domestic debt also diminishes the value of the currency. As a nation’s internal or external debt increases, it puts pressure on the government to limit their spending locally. Externally, a weaken economy creates trade deficits and diminish revenue collection as the exchange rates of the currency is devaluated.
Given this bleak economic outlook, the government has embarked on bold economic recovery initiatives that will restore fiscal integrity and promote strong exchange rates through the following objectives. To achieve these objectives, the following policies have been adopted: strengthening revenue collection through a speedy rebuilding of the integrity and capacity of the Kenyan Revenue Authority and proper tax system; reducing wage bill as part of total expenditure reformation thus resetting wage standards for public and civil servants and finally restructuring the financial sector to increase efficiency and decrease government liabilities. Fiscal program is aimed at restoring fiscal integrity and debt sustainability, providing resources for poverty reduction spending and positioning the economy on a sustaining, poverty-reducing growth path. Tax reform will improve neutrality, simplicity and revenue-yielding capacity aimed at broadening the tax base. The PRSP will be expanded to tackle poverty by providing opportunities for the poor through reformation in agricultural sector and encouraging medium growth and small-scale enterprises among others. Accepting this loan will enable the government to put strong economic measures in place to combat policy deficiencies that will promote strong exchange rates.
References
Carbaugh, R. J. (2004). International Economics, 9th edition. Mason, Ohio: South-Western,
Thomson Learning.
. http://www.bis.org/cbanks.htm
Federal Reserve Bank of New York. United States,
International Monetary Fund (2003). Kenya and the IMF,