Mark G. answered • 01/01/21
Finance Professional, Personal Investor and 5 Yrs Tutoring Experience!
The macroenvironment has a lot of subtle nuances that is difficult to capture on a large scale though, from experience, we can note the changes that typically would occur given different policy changes.
The current US interest rate is a dramatic 0% and in fact the Central Bank is spending trillions of dollars to purchase their own bonds, a program called Quantitative Easing, which has the impact of further reducing broad interest rates, props up the bond and stock market and many businesses that may fail otherwise, and will create inflation in the future - hopefully once the velocity of money begins to pick up. In the meantime, there is still a tremendous amount of inflation in investable assets (equities, real estate, and so on).
If the interest rate were to rise to 4%, this would be deadly for the economy. A number of things would happen that would be very painful.
Firstly, many businesses that will need to refinance their loans will have to do so at a higher rate and they may need to declare bankruptcy. Similarly, the cost of borrowing for other businesses and governments will increase dramatically which will harm their ability to stimulate the economy through other fiscal measures. Equity markets will be hurt in a number of ways including because some money will be shifted into bonds and also because the discount rate for future cash flows will be much higher, hurting the present value of a company's stock. Increasing interest rates this high will also strangle out any inflation before it even has an attempt to rise. As a result of all these factors, unemployment will inevitably rise and people will suffer. The only true beneficiaries of this are those on a fixed income (and will be glad that inflation does not rise) and savers that don't invest (which will appreciate earning higher amounts in GICs/savings accounts).
If the exchange rate were to depreciate 5%, there is also a number of factors that would happen which is broadly considered to be quite a positive development for the United States market. Firstly, our export industries will perform better because our money is now cheaper abroad. The automotive sector, manufacturing sector, and all others that sell products overseas will become more competitive. On the flip side, this will make imports more expensive which can be both a positive for exporters though also a negative for those that need to buy raw materials overseas to create finished products in the United States. This may result in some inflation passed on to consumers as a result of a greater cost to businesses. Lastly, our trade deficit would shrink as exports will be relatively higher than imports and this is another positive for the US economy.
Subsidies help the people and industries that are targeted. Since this is not a specific example, let's pretend that the government is providing a $100billion subsidy to the oil and gas industry. Naturally, this will be very beneficial to that sector. This money may save some companies from failing and keep people employed, thus resulting in a lower unemployment rate. This will also increase the stock of those companies that are being helped. Our domestic gas industry will be more competitive, exports may increase, more investment and development may occur and we will become better protected against our reliance on oil from the Middle East and Russia and others. These are all net positives. On the flip side, the "free market enthusiasts" would suggest that if these companies can't succeed, then we should let them fail.
Increasing taxation to pay for this subsidy will result in lower money to be spent by everyone else, depending on where the tax falls. If it is consumers paying the tax, this means less money for them to spend on consumer goods and less money to meaningfully impact the broad economy. This also means they have less money to save and to pay down debts, again harming the consumers.
