U.S. Economy 2004 - 2005

U.S. Economy 2004-2005
EC303
05/01/2013

The U.S. economy has seen its share of glory and uncertainty over the last century. Going from a leading economic giant to the assumed financial capital of the world, each year brings new challenges for the economy. This paper will examine and highlight growth, price level, interest rates and monetary policy during 2004 and 2005. Gross domestic product (GDP) is the market value for all goods and services produced, also known as economic output, within the U.S. during a specific time period (Mishkin, 2010). The total economic output is typically measured by GDP. The U.S. economy saw robust growth in 2004 and 2005 despite many issues including federal budget deficits, Hurricanes Katrina and Rita, Social Security reform, high oil prices, the looming housing bubble, and the Chinese exchange rate policy. The United States economy grew at an annual rate of 4.4% in 2004 and productivity growth is the key reason for the strong performance (Coughlin, 2005), see Attachment A. Growth in 2005 continued to exceed even the most optimistic projections reaching 4.3% in the fourth quarter. The inflation rate is significant because it describes how prices are changing over a period of time. Inflation is a positive number when prices are going up and negative when prices drop (which is rare). Mishkin maintains that “inflation, a continued increase in price level, affects individuals, businesses, and the government; and is generally regarded as an important problem to be solved and is typically at the top of political and policy making agendas (Mishkin, 2010)”. The government uses the Consumer Price Index to calculate the rate of inflation and it is one of the most significant measures of economic progress. Inflation in 2004 moved higher during the first six months of the year than it had over the previous 4 years. Over the first half of the year, energy prices and consumer prices soared. Consumer prices rose faster than most employees’ wages, 2.5% as compared to the same period in 2003. Crude oil and gasoline prices increased in addition consumer food prices are primarily blamed for inflation in addition to copper and lumber prices, which are said to have contributed to the increase in core inflation (Federal Reserve, 2004). The federal funds market is a market in which banks borrow and lend balances in reserve accounts, typically on a very short term overnight basis. The banks use the reserve balances to meet reserve requirements and to settle payments, borrowing when they’re short of funds and lending when they have excess. Fed open market operations (both temporary and permanent) and lending function to accommodate banks’ demand for reserve balances given daily changes to the Fed’s balance sheet beyond its direct control. The Fed’s primary lending facility lends to all banks at one percent above the targeted federal funds rate. By eliminating the non-monetary costs historically associated with borrowing from the Fed, and lending at a “penalty rate,” the Fed is operationally similar to other central banks that have chosen to directly limit the upside potential of the overnight rate. Not surprisingly, the New York Fed (2004) reports that the primary lending rate has resulted in reduced deviations on the upside from the targeted rate (Fullwiler). To fight the recession in 2001, the Fed lowered its rates and continued to decrease rates in 2002 and 2003 to stimulate the economy. Once the economy began to recover, the Fed began to slowly raise rates beginning in summer in 2004 in an attempt to avoid inflation. The gradual increase in rates lasted through mid-2006 (BB&T, 2013). Monetary policy is what the Federal Reserve does to influence the amount of money in the U.S. economy and what happens to money and credit affects interest rates and the overall performance of the economy. The primary goals of monetary policy are “to promote maximum employment, stable prices and moderate long-term interest rates. By implementing effective monetary policy, the Fed can maintain stable prices, thereby supporting conditions for long-term economic growth and maximum employment (Federal Reserve ).” The Fed uses several types of open market operations to influence the economy. In the first few months of 2004, the Federal Open Market Committee held an accommodative monetary policy stance together with a robust fundamental growth in productivity, provided ongoing support to economic activity and maintained its target for the federal funds rate at 1%. At a press release in mid-2004, the Fed stated that “the Committee perceives the upside and downside risks to the attainment of sustainable growth for the next few quarters are roughly equal. Similarly, the risks to the goal of price stability have moved into balance. At this juncture, with inflation low and resource use slack, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured (The Federal Open Market Commitee, 2004).” By the end of 2004, the Fed had increased the federal funds target to 2.25% and continued to have an accommodative monetary policy stance. The Federal Open Market Committee decided to further increase it funds rate target by 25 basis points to 2.50% in February of 2005. With output growing at an acceptable pace despite the rise in energy prices as mentioned earlier in this report, inflation at the beginning of the year did not appear to pose a threat to the economy. The Fed increased the funds target rate several times throughout 2005 in response to pressures on inflation picking-up through the middle of the year. Hurricane Katrina devastated the Gulf region and created uncertainty in the market, despite concerns for short-term uncertainty, the Fed held monetary policy accommodation. By December of 2005, the Committee had raised the target for the federal funds rate to 4.25% and the Board of Directors approved another increase to the discount rate, ending at 5.25%. In the last press release for the year, the Committee mentioned that some restrained policy firming may be needed to sustain economic growth and price stability and that any additional action would be discussed in the beginning of 2006 (Federal Reserve Release, 2005). The U.S. economy saw many challenges during 2004 and 2005, despite those hurdles, GDP growth was very strong in 2004 and exceeded expectations in 2005. Corporate profits, job creation and employee compensation also rose significantly while the unemployment rate decreased until the fourth quarter of 2005. While the spurt of overall growth in the economy was positive for most, the economy is not bomb proof and would soon experience the devastation of the financial crises beginning with the burst of the housing bubble in the years following. The U.S. economy remains a financial global giant.

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Attachment A
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[pic] (Coughlin, 2005)

Works Cited

BB&T. (2013). The Federal Reserve and Interest Rates. Retrieved May 1, 2013, from http://www.bbt.com/bbtdotcom/financial-education/planning/federal-reserve-and-interest-rates.page
Coughlin, C. C. (2005). U.S. Economic growth, Relatively Speaking. St. Louis: Federal Reserve Bank of St. Louis.
Federal Reserve . (n.d.). Federal Reserve Education. Retrieved May 1, 2013, from Monetary Policy Basics: http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy/
Federal Reserve. (2004). 2004 Monetary Policy Report to the Congress.
Federal Reserve Release. (2005, December 13). Press Release December 13, 2005. Retrieved April 1, 2013, from Monetary Policy releases: http://www.federalreserve.gov/boarddocs/press/monetary/2005/20051213/default.htm
Fullwiler. (n.d.). Setting Interest Rates in the Modern Money Era. Wartburg College and the Center for Full Employment and Price Stability.
Mishkin, F. S. (2010). The Economics of Money, Banking & Financial Markets 9E. Boston: Pearson Education, Inc.
The Federal Open Market Commitee. (2004, May 4). Press Release May, 4 2004. Retrieved May 1, 2013, from http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040504/default.htm

Cited: BB&T. (2013). The Federal Reserve and Interest Rates. Retrieved May 1, 2013, from http://www.bbt.com/bbtdotcom/financial-education/planning/federal-reserve-and-interest-rates.page Coughlin, C. C. (2005). U.S. Economic growth, Relatively Speaking. St. Louis: Federal Reserve Bank of St. Louis. Federal Reserve . (n.d.). Federal Reserve Education. Retrieved May 1, 2013, from Monetary Policy Basics: http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy/ Federal Reserve. (2004). 2004 Monetary Policy Report to the Congress. Federal Reserve Release. (2005, December 13). Press Release December 13, 2005. Retrieved April 1, 2013, from Monetary Policy releases: http://www.federalreserve.gov/boarddocs/press/monetary/2005/20051213/default.htm Fullwiler. (n.d.). Setting Interest Rates in the Modern Money Era. Wartburg College and the Center for Full Employment and Price Stability. Mishkin, F. S. (2010). The Economics of Money, Banking & Financial Markets 9E. Boston: Pearson Education, Inc. The Federal Open Market Commitee. (2004, May 4). Press Release May, 4 2004. Retrieved May 1, 2013, from http://www.federalreserve.gov/boarddocs/press/monetary/2004/20040504/default.htm