Tuesday, January 18, 2005

The Economy Is Good But Not Great - The Government's Dirty Little Secret

We've heard from a lot of sources, especially from sources that support the Bush administration but also including independent analysts as well as Allen Greenspan, that the economy is in full recovery and frankly they're right...to a point. GDP is expected to increase by 3.5% to 4.7% depending on who you ask. The Federal Reserve says that "inflation and longer-term inflation expectations remain well contained." Everything is looking peachy except for one thing: Jobs. Jobs just haven't increased at the rate so many expected. There's little doubt that the Bush tax cuts has helped push the economy in the right direction, but they've fallen short of their expectations when it's come to job recovery.

Now this brings me to the government's dirty little secret. They don't control the economy. This may come as a shock to most people, but the government has very little control of the economy. Now this hasn't prevented many presidents from taking credit when the economy is good and it hasn't prevented many presidents from being voted out of office when the economy is bad. The truth is, the government can do little more than give light pushes in a general direction.

Now I'm not saying that over the long term a government can't grind an economy into the ground or encourage it to new heights. The government's best role is in creating an atmosphere where the economy can thrive and the United States is one of the best atmospheres in the world for an economy to thrive.

The Federal Government can only do two things with regards to the economy: Tax and Spend. During a recession, if a government decreases taxes and increase spending, these two acts can, in the short term, increase the amount of investment and spending done by businesses and consumers and provide work for companies.

The Federal Reserve has two things it can do: Change the amount of money that is in the economy and change interest rates. During a recession, if the Federal Reserve decreases interest rates and increases the amount of money in the economy (by printing money and/or buying T-Bills), these two things encourages businesses and people to spend and invest more whether it is in a new home or in new machinery or a new factory.

These things that the Fed and the Government can do is nothing more than encouraging the economy to improve.

During the 2000 recession, the federal government has decreased taxes and increased spending (thanks in part to the War on Terror). The Federal Reserve has lowered taxes (I'm not sure what they have done with regards to the money in the economy). The result? People have bought homes and cars like crazy. Businesses have invested more and purchased new capital. These things have increased our GDP and the stock market is on a positive trend. Usually in this situation, when businesses have more money, they also hire more people and invest in human capital as well, which they have, just not as much as expected.

"On Jan. 2, 2004, The Wall Street Journal reported that 54 economists it surveyed believed that 'rising corporate profits and steady economic growth are expected to prompt companies to hire workers more aggressively in the months ahead....'

This economic recovery is creating new jobs (and 2004 was the best year since 1999), but it's not creating enough new jobs to support a full recovery from a recession. And no one — not private-sector economists, not academic economists, not Council of Economic Advisors economists — had forecast such a scenario."

So whose fault is it? Nobody really. Congress and the president have done everything within their power. Allen Greenspan has done everything within his power and they've gotten results but they cannot force businesses to hire. They can encourage it but they can't force it.

And this is my main point. My grandmother told me once, "Never take too much credit or blame for what your kids do." Likewise, the Federal Government and the Federal Reserve, despite what they would have you believe, can't take too much credit or blame for the economy. They have done well to push it in the right direction, but we should think twice about hammering them when the recovery isn't perfect.

(the numbers and quotes taken from an article written by Susan C. Walker)