There are three leading economic indicators, Economic Growth rate (%∆ in Real Gross Domestic Product or %∆RGDP), Inflation Rate (%∆CPI), and Unemployment Rate (U). The target for US Economy...

There are three leading economic indicators, Economic Growth rate (%∆ in Real Gross Domestic Product or %∆RGDP), Inflation Rate (%∆CPI), and Unemployment Rate (U). The target for US Economy is to be at Full Employment. Historically data suggests that US Economy is at Full Employment when the following data prevails:

%∆RGDP around…3%

%∆CPI (Inflation Rate)… between 1% and 2%

U = Natural Unemployment Rate = Frictional U + Structural U = between 4.5% and 5.5% Unemployment Rate.

Based on the above information, answer the following two questions, your answers should be as detailed as possible:

  1. Assess the state of the Economy: Are we at full employment? Are we in danger of a recession or already in a recession? Should we worry about inflation? Stagflation? What should be our main economic concern?
  2. Recommend an Economic Policy. Suggest a Fiscal Policy, Monetary Policy or a combination of them to deal with the problem, if there is a problem. You are free to use any economic policy, including Classical, Neo-Classical, Monetarist and Keynesian policies.
Expert Answers
pnrjulius eNotes educator| Certified Educator

For your convenience, I've added reference links to interactive official Federal Reserve graphs of all three of these indicators.

We may not quite be at full employment, but we are fairly close. Our current unemployment rate is 4.9%, so under the usual assumption that "full employment" means about 4.5% unemployment we're almost there.

We are definitely not in a recession anymore. Smoothing over some unusually strong seasonal variation, our current growth rate in real GDP is about 2.3%, which is a bit slow but definitely positive.

Inflation is also definitely not a problem---actually deflation may be a problem, as our current growth rate in the CPI is only 0.1% and falling. If we do hit another recession soon, it will likely be because this deflation has not been stopped.

Stagnation might be an issue, particularly if this already somewhat slow GDP growth slows down any further. But stagflation isn't, because inflation is too low, not too high.

But the main concern for me at least is not on any of these indicators---it is our interest rates, which remain extremely low, just slightly above zero. If we do suffer deflation, or even if we simply can't get inflation back up closer to 2%, our real interest rates will also be nearly zero, which effectively removes the Federal Reserve's ability to expand the money supply and thereby bring us out of a recession. This is called the zero lower bound.

Monetary policy is basically powerless here; only fiscal policy could solve this problem. Speaking from the consensus position of macroeconomists today (which is more or less Keynesian, generally called the New Neoclassical Synthesis), the best thing to do right now would be to greatly expand the government deficit by spending on worthwhile projects such as education and infrastructure development. This would boost the economy directly and also put upward pressure on interest rates to raise them above the zero lower bound. This would hopefully bring GDP growth back up to target, and it would give monetary policy a lot more room to restore the balance when we do hit another recession (which, if history is our guide, is only a matter of time).