The US solutions on debt ceiling and further recovery policy

Markets are closed at weekends but not political debates. Consequently, the need for constant vigilant remains essential. The political negotiations regarding additional borrowing in the US went quite smoothly last week and it seemed that the deal on a new $2.4 trillion borrowing was reached. However, according to the president Obama's remarks released on the last Friday’s evening, Speaker Boehner was going away from the final deal, therefore, setting up uncertainties regarding the further recovery policy of the US economy.

A short-term extension of the US debt ceiling which should be settled till the 2nd of August in order the US was able to avoid a default on its debt was considered alongside with the deficit reduction options. According to the political negotiations the $650 billion cuts from Medical, Medicaid and Social Security programmes could be achieved immediately and budget deficit might be reduced by $4 trillion over the next 10 years. Although the solutions to cut ineffective spending were worked collectively the disagreement between the Republicans and the Democrats aroused regarding the Democrats’ suggested additional revenues. It was proposed to raise $1.2 trillion budget incomes by eliminating loopholes, some deductions and initiating a tax reform that could have lowered tax rates generally while broadening the base.

The US default on its debt may ruin the whole financial system in a moment. Thus, the US has no choice but to increase its short-term debt ceiling. The financial markets judge politicians on their short-term solutions. However, should the current state of economy become worse to empower significant decisions whose change trends of long-term recovery.

The role of the economic policy

The imbalance of the global economy and the threat of the possible double dip recession force to reconsider the role of economic policies. Like never before, functions of states to identify key guidelines of development of domestic economy should be reassessed in order the private and public interests were balanced along with restitution of domestic justice and efficiency.

The main driver of economy is demand. Thus, let’s review where the demand comes from. The criterion which may characterise the propensity to consume and determines the growth of economy is profit. In addition, it is assumed that the greatest efficiency is achieved in the market economy. However, the circumstances of perfect competition create superior conditions for domination of monopolies those dictate prices of goods and services. Consequently, the trends of global economy are also under their influence.

Thus, I consider how important the states’ economic policies are nowadays. Moreover, how long it could take for the governments of states to retrieve their authority and intellectual creativity, rethink the concepts of the states’ economic policies so that the global economy distortions were reduced and social justice recovered?

Volatility may be provoked

The Governing Council of the ECB decided to increase the key interest rates by 25 basis points to 1.5% on the 7th of July due to the high inflation in euro area. The annual HICP inflation was 2.7% in June 2011 that is inconsistent with the primary objective of the ECB’s monetary policy to maintain inflation rates below, but close to, 2% over the medium term. According to the introductory statement to the press conference such anchoring is a prerequisite condition to the economic growth in euro area. However, the ECB’s attempts to strengthen euro by increased key interest rates may evoke even higher volatility. The results of the EU wide stress test will be announced on Friday, 15 July. Moreover, participants of the financial markets are sensitive to news those increase burden of the “peripheral” countries to manage their debts.


According to the EU wide stress test scenario based on the ongoing EU sovereign debt crisis, the domestic demand of the euro area will decline affecting consumption and investment. It is assumed that the long-term interest rates will go up by 75 basis points, stock prices will fall by 15%, house prices will decline, tensions regarding the European money market will renew and contribute to an increase in short-term interest inter-bank rates by125 basis points. Considering the scenario which involves global negative effect of the US policy and a USD depreciation vis-à-vis all currencies, the private consumption and investment will be getting worse; however, it is assumed that both oil and non-oil commodities will be unaffected and the monetary policy will be unchanged. Considering the circumstances mentioned above it is anticipated that the overall effect of the EU-specific and external environment shocks will reduce the GDP growth by around 2% in both 2011 and 2012 and HICP will be lower by 0.5 and 1.1 percentage points for the euro area.

Although the ECB expects that the increased interest rates will reduce inflation and contribute to enhance economic growth, higher energy and commodity prices those are the main reason of the increased HICP little can be changed by such decision. Moreover, when the increased interest rates are used to reduce monetary liquidity and at the same time the opposite actions such as emergency liquidity to assist banking system in the event of crisis are considered it leads to higher volatility in the financial markets. Thus, I wish the ECB was able to identify though was not following the anticipated negative scenarios of the EU wide stress test.