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The U.S. Economy – How it is operating Essay

The U. S. Economy is the largest and most powerful economy in the world with a Gross Domestic Product close to $14 Trillion at the third quarter of 2007. In a three year period starting in 2004, the U. S. economy exhibited great resiliency by weathering critical events. The aftermath of the September 11 terrorist attacks led to major shifts in national resources to fight global terrorism. The costly war in Iraq led to a more costly U. S. occupation in Saddam Hussein’s country. Budget, resources and human capital were huge investments in the war front.

During the same period, Hurricane Katrina caused extensive damage in the Gulf Coast. Again, vital resources were sacrificed to aid victims and their families as well as affected areas. Soaring oil prices in 2005 and 2006 also threatened the economy specifically rising prices and the number of unemployed. This too tested the American economy to its limits. Despite these setbacks, the U. S. economy posted strong growth by the third quarter of 2007 showing that the world’s mightiest economy is as stable as ever.

Looking ahead, the economy still faces long-term problems including inadequate investment in economic infrastructure, rapidly rising medical and pension costs of an aging population, sizable trade and budget deficits, and stagnation of family income in the lower economic groups. Productivity (Gross Domestic Product) Starting in 2004 through the third quarter of 2007, the U. S. Economy showed strong GDP growth – 2. 9% in 2004, 3. 2% in 2005 and 2006 and a leap to 4. 2% at the end of the third quarter of 2007.

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According to the Bureau of Economic Accounts, the increase in GDP primarily reflected increases in consumer spending, investment in equipment and software, federal government spending, and residential fixed investment. The President, in his State of the Economy address in January 2007, highlighted the strong and dynamic economy, and discussed the challenges faced in keeping the economy growing. The President stressed that the U. S. economy is resilient and responsive, adding more than 7.

2 million jobs since August 2003 despite numerous challenges including a recession, corporate scandals, the 9/11 attacks, and the worst natural disaster in American history. CPI and Inflation The Consumer Price Index is a measure of the average change over time in the prices paid by consumers for a market basket of consumer goods and services. During the period 2004 to 2006, CPI rose at a manageable level – indicating inflation is under control. In 2004 – CPI rose 3. 3 % over the previous year. In 2005, the rate was at 3.

4 % and in 2006 it slowed down to 2. 5%. The recent behavior of inflation bodes well for the long term. As inflation remains low and stable it has minimal impact on economic decisions such as the ability of businesses to plan for the future. The absence of inflation pressures also means that the Federal Reserve would have policy room in which to maneuver in the near term. (U. S. CPI) Unemployment/employment According to the Bureau of Labor Statistics, non-agricultural employment rose by 166,000 in October, and the unemployment rate was unchanged at 4.

7 percent. Job gains occurred in professional and business services, health care, and leisure and hospitality. Manufacturing employment continued to decline, and construction employment was little changed. The number of unemployed persons was 7. 2 million in October 2007. A year earlier, the number of unemployed persons was 6. 7 million, and the jobless rate was 4. 4 percent. Also according to the BLS, total employment was at 146 million in October. The employment-population ratio was at 62. 7 percent. The civilian labor force was at 153.

3 million and the labor force participation rate was at 65. 9 percent. Balance of payment The country’s balance of payment particularly the relationship between the country’s exports and imports still show a deficit. The deficit decreased to $190. 8 billion in the second quarter of 2007 from $197. 1 billion in the first quarter. According to the Bureau of Economic Analysis, a decrease in net unilateral current transfers to foreigners and increases in the surpluses on services and on income more than accounted for the decrease.

Interest Rates and its effect on the Economy The Federal Reserve System, the independent U. S. central bank, manages the money supply and use of credit (monetary policy), while the president and Congress adjust federal spending and taxes (fiscal policy). The Federal Reserve’s monetary policy has stressed preventing rapid escalation of general price levels which usually leads to inflation. The Federal Reserve acts to slow economic expansion by reducing the money supply, thus raising short-term interest rates.

When the economy is slowing down too fast, or contracting, the Federal Reserve increases the money supply, thus lowering short-term interest rates. The most common way it effects these changes in interest rates, called open-market operations, is by buying and selling government securities among a small group of major banks and bond dealers. A particularly tricky situation for monetary policy makers, called stagflation, occurs when the economy is slowing down and general price level (inflation) is rising too fast (U. S. Monetary Policy).

In the past year, then Federal Reserve Chairman Alan Greenspan wrapped up an eventful 18-year career Tuesday with a final interest rate hike and cleared the way for his successor Ben Bernanke to bring the long credit-tightening campaign to a close. Acting on Greenspan’s final day in office, Federal Reserve Board raised the benchmark overnight lending rate another quarter-percentage point to 4. 5 percent, pushing up borrowing costs for consumers and businesses in their ongoing bid to keep a lid on growth and inflation (Wolk).

In the months after that, the Board came up with a series of cuts in interest rates to address the prevailing economic condition. This balancing act is in line with the Federal Reserve’s responsibility of trying to maintain full employment (generally considered to be around 4 to 5 percent unemployment) while keeping inflation low. One can imagine the risks and uncertainties involved in such act. Alan Greenspan once said, “Policymakers often have to act, or choose not to act, even though we may not fully understand the full range of possible outcomes, let alone each possible outcome’s likelihood.

As a result, risk management often involves significant judgment as we evaluate the risks of different events and the probability that our actions will alter those risks (Greenspan). ” . This delicate balancing act is done by using interest rates as a tool. When interest rates are low, capital is easier to acquire. Left unchecked, however, this leads to inflation. If interest rates are too high, however, the result can be a recession and, in extreme cases, deflation; the result of which can be economically devastating.

There are two ways as to how the Federal Reserve influences the direction of interest rates: by raising or lowering the discount rate or by indirectly influencing the direction of the Federal funds rate. The discount rate is the interest rate banks are charged when they borrows funds overnight directly from one of the Federal Reserve Banks. The Federal funds rate is the rate that banks charge each other for overnight loans (U. S. Monetary Policy). Conclusion Not too many believed that the U. S. economy can rebound so fast from the series of unfortunate events of 2004 to 2007.

Yet the number one economy in world has proven its resiliency and durability by weathering these storms. Much of the credit should go to the managers of the economy. The adoption of effective policies and strategies were the keys to sustaining the growth even in the midst of uncertainties. Greater challenges loom ahead. The economy still faces long-term problems including inadequate investment in economic infrastructure, rapidly rising medical and pension costs of an aging population, sizable trade and budget deficits, and stagnation of family income in the lower economic groups.

The country will call on again the time tested policies to deal with these adversities. As President Bush said “Our economy is on the move and we can keep it that way by continuing to pursue sound economic policy based on free-market principles. ”

Works Cited

Greenspan, Alan. “Risk and Uncertainty in Monetary Policy (Remarks at the Meetings of the American Economic Association, California). ” January 2004. November 2007 <http://www. federalreserve. gov/boarddocs/speeches/2004/20040103/default. htm> United States. Balance of Payments.

Bureau of Economic Analysis November 2007. November 2007 < http://www. bea. gov/international/index. htm#bop> United States. Consumer Price Index. Bureau of Labor Statistics November 2007. November 2007 <http://www. bls. gov/cpi/> United States. Gross Domestic Product. Bureau of Economic Analysis. November 2007. November 2007 <http://www. bea. gov/national/index. htm#gdp> United States. Monetary Policy and the Economic Outlook. The Federal Reserve Board: July 2006. November 2007 <http://federalreserve. gov/boarddocs/hh/2006/july/ReportSection1.

htm> United States. Bureau of Labor Statistics. “Overview of BLS Statistics on Inflation and Consumer Spending” November 2008, November 2008 <http://www. bls. gov/inflation/> United States. State of the Economy Report. July 2006, November 2007 <http://www. whitehouse. gov/infocus/economy/> United States. U. S. Monetary Policy. November 2007. November 2007. < http://federalreserve. gov/monetarypolicy/default. htm> Wolk, Martin. “Fed hikes rates again as Greenspan wraps term. ” January 2006. November 2007 <http://www. msnbc. msn. com/id/11104282/>

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