In the recent past, the U.S. economy has undergone a period of relatively slow,
ID: 1116215 • Letter: I
Question
In the recent past, the U.S. economy has undergone a period of relatively slow, steady growth. Political events in the Middle East have demonstrated that potential for instability in the supply of oil. a. Presumably, the U.S. government would like to continue on this path of growth. b. Briefly outline a combination of fiscal and/or monetary policy aimed at c. Describe how certain policies could lead to a "stagflation" in light of potential Describe how political events could work to thwart this aim. continuing economic growth even if the supply of foreign oil is severely curtailed. supply shocks in oilExplanation / Answer
A.
The US government would like to continue the slow and steady growth of the economy, but it depends upon the global events also. The economy requires stable oil supply and any issue with the supply can thwart the growth targets. For example, the outburst of war in the middle-east region between the Saudi Arabia led countries and Qatar (due to escalated tension in recent times). Or the recent action by the Crown prince of Saudi Arabia to hostage the many other princes of the country has the potential to escalate tension in the region. It will disrupt the oil supply to the USA. Besides, the aggressive initiatives by Iran and the disrupting influence of IS-IS can also cause disruption in oil supply. It will cause less industrial output in the USA that will negatively affect the employment and production of goods in the country.
B.
The reduction in supply of oil will cause the oil price to increase. It means that the bigger portion of disposable income will be consumed on oil or rising prices of goods due to increase in price of oil. It can controlled by monetary and fiscal policy in the economy. Government can reduce the taxes so that relatively bigger disposable income is available to spend. It will compensate the lost income due to the rise in price of oil. Further, government purchase will compensate the reduction in aggregate demand due to price rise. An easing monetary policy with a lower interest rate will also help in controlling the negative effect of poor oil supply and firm will continue to make investment spending.
C.
In stagflation, unemployment rate is high as well as the inflation rate is also high. Economic growth decreases during the scenario of stagflation. During the oil shock, price level will rise. It will also cause the cost of production to increase, leading to the rise in price of finished goods. It causes the increase in inflation. As a policy, if government decreases the purchase or increases the tax, then it causes the aggregate demand to come down, further supply will also be discouraged as household demand and government purchase, both are coming down. Due to this discouragement, supply will come down and people will become unemployed while inflation rate is already high. Now, a chain of negative economic activities takes place where economic growth decreases due to decrease in AD and then AS, unemployment increases due to the closure of the factories and inflation rate is high due to oil shocks and rising input costs. It creates a case of stagflation.