The Complicated Relationship Between the Government and the Economy

Written by: Seth Rogers
08/07/2019

government-economy

At its heart, the government is meant to work for the people that it represents. The Federal Reserve is part of the government, but the relationship between the government and the Fed is more complicated because the Federal reserve chairman is appointed by the President rather than being elected by the people. The economy is the best barometer of the effectiveness of the policies that each president is putting in place and the Federal Reserve will always be in the middle trying to captain the economy’s ship. 

The government makes laws and sets policy, while the Federal Reserve has a dual mandate of maintaining and promoting full employment and an inflationary environment that is normalized at around two percent. There is so much vitriol in our current political environment that precludes simple analysis and reflection on how we can get the economy working for us over the long-term. It is a shame that we also don’t focus on how the government is performing in solving the biggest problems of the day. The economy could be thought of as the report card for government and the policies and laws that it is putting in place. The general manager of the economy is the Federal Reserve and it has multiple fiscal tools at is disposal to impact the economy.

The biggest action that the Federal Reserve can take to impact the economy is to adjust interest rates. Without getting into too much arcane detail, the interest rates that the Federal Reserve impacts the amount that we pay for big ticket purchases like our housing and auto loans among other things. When the economy is heating up, the Federal Reserve often tries to raise interest rates in an effort to tamp down prices and cost of products and services. Rapid inflation can be a big issue that is very hard to control once it gets traction so the Fed is vigilant on not letting inflation get too far out of that two percent range over time. Conversely, the Federal Reserve can cut interest rates if it wants to be stimulative and get more action going in the housing and investment markets.

Right now there is debate in the government on the actions that the Federal Reserve is taking. The growing school of thought is that the Federal Reserve must start to cut interest rates more aggressively to combat a looming recession. The President has made remarks about this subject which always ratchets up the pressure on the Federal Reserve. Throughout its life, the Federal Reserve as an institution has attempted to stay out of politics by acting in a bipartisan fashion. The health of the economy is what the Fed is attending to over the long-term so it should not be influenced by the whims of the government who is often looking out for its own short-term best interests. 

The truth is that the elected officials that make up the government are looking to get reelected at all costs. That is almost every elected officials first goal if they were being honest. You can see the results of this motivation in almost every decision that is made by the government. There are certainly party lines to be followed but at the end of the day, reelection is the biggest motivator of the typical government official. That is a shame but it must be acknowledged to properly assess the economic landscape.

The economy might be doing well now due to the actions of the Federal Reserve and the government, but there is a long-term trend that also needs to be addressed here and that is the amount of debt that is being run up by the government. Our country has consistently spent more on expenditures than it takes in from taxes over the most recent decades. This is not a sustainable path to take for the next century because our country has to pay that debt back plus interest which will become increasingly difficult as the total debt balance continues to grow. Our government officials have steadfastly refused to address this long-term problem because the solution is difficult and unpopular. The solution is that either taxes need to be raised or expenditures need to be cut. Those are the two alternatives to get our of our debtor position. 

The fact that the government is more short-term focused is causing problems in addressing the biggest issues of the day. Our government officials have not found a viable way to agree on how to address climate change or our looming debt crisis and a litany of other important topics. They instead choose to argue between parties about whose short-term solutions are the most effective. In actuality, the government should be working towards solving our largest long-term problems while at the same time reducing our debt burden with a comprehensive solution. This is much easier to do now when the economy is still on stable footing. The party system that we have in our country does have some obvious benefits, but it also clouds the judgement of elected government officials. They often get so stuck on trying to find ways to argue with the other party that solutions are not pursued for fear of being labeled a moderate. 

Highlighting the big picture of the interconnections between the Federal Reserve, the government and the economy is vital to understand macroeconomic trends. There is no problem that our government couldn’t solve if it focuses its resources on finding the most practical solution to the problems that we are facing. The problems that we have in front of us will need to be solved with a team effort. They will not be solved by one party alone. The government is run for the next election cycle right now but it is imperative that we should start demanding that the government be run for the next generation. We want our kids and grand kids to have better lives than we have lived. To make this a reality, we need government to work for the next generations as well as the current one.


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