Business advice

How does the government mess with the economy?
December 28, 2008, 7:47 am
Filed under: Blogroll, Business Advice | Tags: , ,

We have all heard that our credit problems are because of the government. I don’t think so. Prior to the depression, the government’s attitude towards the economy (aggregate market), was to leave it alone. We all know the results.

Now we have a government that uses fiscal policy (public spending) to adjust the economy. If you have never heard of this, simply Google the term and you will get a brief definition. Previous to the government spending aspect, the only way governments could get money if they needed it was either taxation or seizure of private property.

Fiscal policy/government spending is a tool used by the Federal government. You know the government allocates a good portion of money every year to government contracts. If all this was left to the private sector, things would be worse than they are. Now, I am not saying that I endorse the way the government awards contracts. I’m just saying that they do.

They also have the right to either lower or raise taxes and institute new ones if they are able to get such a law through Congress.

The other side of this coin is monetary policy. Monetary policy refers to how the Federal Reserve’s use of interest rates and the money supply to guide economic growth.

The overall theory goes like this: once interest rates go down; there will be more activity in the aggregate. If interest rates are down it is a green light for borrowers to go ahead and apply for more loans. It also makes it easier for the lenders to get customers to sign on the bottom line. It is an encouraging sign for the stock market. If there is more borrowing, there will be more corporate expanding and an increase in products sold (GNP). When such announcements come out, they, the stock market, respond by having a day where there is more buying than selling.

The Fed has other tools by which to expand the money supply. An expanded money supply encourages growth. (In case you are wondering the definition of the money supply is so complex, it takes an economist to try and explain it. There is also controversy over which figure the Fed uses to make its decisions. Enough already.)

When the Fed feels there isn’t enough money in the money supply, they can lower the banks reserve ratio. All banks have a reserve ratio. The rest of the money they take in, they put out in loans to earn money. You really didn’t think they kept all that money right there all the time I hope. When they are allowed to loan out more, then there is more money in circulation.

Then there is the business of government securities. You have all heard of T-bills and other treasury bonds. The Fed has the right to buy and sell them. If they want more money in circulation, they issue a buy order. Customers with bonds they had been holding go to the nearest Federal Reserve Bank and sell their bonds. They are issued a check, which they are going to go and deposit in their bank. This money prior to this deposit never existed. There is, as we know, nothing to back it other than the full faith of the United States government. The bank, on receiving the seller’s deposit, only keeps its reserve requirement portion of the deposit. The rest is circulated to others who apply for loans. They then take the loan check and deposit in their personal bank. The same thing is repeated until that original check for the sale is exhausted. Now, that money is in circulation, less whatever the reserve ratio was for the individual banks.

As bad as things are in the current economy, if the government didn’t have the tools of monetary and fiscal policy, we would be a lot worse off and have fewer options. When things are bad, we always tend to blame the government. They are doing all they can to keep the wildfire that’s sniffing out our financial system from causing a complete collapse. As I said, the only thing that keeps the monetary system going period is that we have confidence in the United States government. Once that confidence is gone, everything will collapse and we will be looking at a situation that makes the depression of the 30s like child’s play.

The only thing we can do now is take care of our own personal finances and write to the legislators if we don’t like what they are doing at their end. Their adjusting the system is not what caused the mess we are in. We had a bunch of greedy corporate bigwigs who thought they could do what they want and we had a whole financial system that came very close to mirroring Enron.

If the government didn’t have the tools it did when those banks collapsed, we would be looking at a situation close to the end of the movie, “Rollover” in 1982. The whole economic system collapsed and there were worldwide riots.

The title of this article was me being factious. We better be glad that the government ‘can mess’ with the economy. This doesn’t mean that we shouldn’t be watching their actions. There is more on the horizon. We need to be dutiful watchers.

For more samples of my work:



1 Comment so far
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Will you be prepared if the dollar collapses??

Comment by jamesad2012

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