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Auto Macroeconomics, Research Paper Example

Pages: 1

Words: 2292

Research Paper

Introduction

The success of a business doesn’t only depend upon internet factors but also factors external to it and Rick understands his business is no exception. Rick owns a manufacturing plant that supplies parts to the auto industry and Rick wonders whether now is the good time to expand the production capacity of his plant in order to take advantage of the potential growth in the auto industry. While it is not possible to be certain whether an industry may grow in the near future, fortunately close examination of certain macroeconomic variables does help in making a reliable prediction of the near future trends. The macroeconomic factors that may help Rick make more informed decisions regarding scale of operations include but not limited to interest rates, GDP growth rate, fiscal policy, monetary policy, and unemployment level.

Macroeconomic Analysis

Few would dispute the fact that the recent financial crisis was the most severe in modern times and is not surprisingly considered the worst crisis since the Great Depression of the 1930s(Paletta, Ng, & Hilsenrath, 2008). One of the hallmarks of economic crisis is declining economic growth and the U.S. economy did officially enter the recession in December 2007 (Isidore, 2008). The Dow Jones Industrial Index declined by more than 20 percent in 2008(Greenstone & Looney, 2012). Even though the U.S. economy is still in recovery phase, significant progress has occurred since then. For example, GDP growth had turned positive by Q3 in 2009 with a growth rate of 1.7percent. In addition, Americans’ real household net worth has also been rising on the average since mid 2009 (The Department of the Treasury, 2012). Things have been even better this year as the U.S. economy grew by 4 percent in Q2(Davidson, 2014) and the expected GDP growth rate for the current year is 2.2 percent (The Heritage Foundation, 2014). While the economy is headed in the right direction in terms of GDP, it is important to understand that monetary and fiscal policies have played an important role in supporting the economy since the financial crisis and it is important to note where they stand at the moment.

As far as fiscal policy is concerned, the U.S. Government increased spending in the wake of the financial crisis in order to stimulate the economy and it is not a surprise that increased spending resulted in budget deficit being almost 12 percent of GDP in the year 2009. When government increases spending, it helps create economic activity which boosts both GDP as well as employment. Since then the government has gradually lowered its spending activities and budget deficit accounted for about 7 percent in the year 2012 (Igan, 2013). The government spending may be declining but the good news for consumers and businesses is that taxes on middle class have also declined in recent decades and now stand near historically low levels. This is true for taxes at both federal and state levels(Marr & Frentz, 2014). Low tax rates on middle class are particularly good policy because middle class tends to have higher income propensity to consume as compared to high income groups. Thus, low tax rates on middle class contribute towards higher aggregate demand levels which in turn helps boost employment level in the economy.

The Fed’s monetary policy has also been instrumental in relatively better performance of the U.S. economy as compared to many developed economies in Europe. Fed lowered the fed funds rate to 0.25 percent in December 2008 (Federal Reserve Bank of New York) and it continues to remain unchanged to this day (Federal Reserve Bank of New York, 2014). By keeping fed funds rate at historically low levels, Fed has hoped that it will encourage consumers and businesses to borrow more due to low cost of borrowing. When it is cheaper to borrow, consumers respond by borrowing more in order to fund their consumption lifestyles and the result is an increase in aggregate demand for goods and services. The low cost of borrowing also encourages businesses to borrow more in order to make capital investments as well as hire more workers to meet the growing demand for their respective goods and services.

The Fed has not been relying on low fed funds rate only to boost the economy. It has also been increasing the supply of money in the economy through bond purchases so as to help keep interest rates low and encourage borrowing by both consumers and businesses. But Fed does feel that the economy is finally gaining much needed traction which may be why it plans to reduce monthly bond purchases from $55 billion to $45 billion(Schneider & Flaherty, 2014). In other words, the economy is still in recovery mode but encouraging signs have been emerging which has prompted Fed to reduce the support it has been providing to help promote economic growth. It is also worth mentioning that consumer spending has been increasing which is a positive sign for producers of goods and services such as the automotive industry.

The current unemployment rate at 6.7 percent continues to be a major concern for the Fed and one of the primary reasons why it is still providing major support to the economy through monetary policies (Schneider & Flaherty, 2014). While it may still be high, the trend over the last few years shows quite an improvement and is another indicator that the economy has been on the road to recovery for quite a while. The unemployment rate stood at 8.1 percent in February 2009 (Willis, 2009) but in a little over five years, it has declined by at least 1.4 percent. The fact that Fed is keeping a close eye on inflation rate and willing to keep interest rates low in order to reduce it(Schneider & Flaherty, 2014) is an encouraging.

As far as inflation rate is concerned, it was quite high in 2008 due to rising food and energy costs (Elliott & Chon, 2008). The inflation rate was 5.6 percent in July 2008 and the average monthly inflation rate for the same year was 3.8 percent. Since then it has come quite down, also due to falling energy costs. The average monthly inflation rate for 2012 was only 2.1 percent and even lower for 2013 at 1.5 percent. The inflation rate at the moment continues to hover around 2 percent mark (Coinnews Media Group LLC, 2014). Thus, the inflation rate may continue to be stable in the near future and it is an encouraging fact that the Fed has been gradually declining the level of its monthly bond purchases.

While it is important to monitor U.S. macroeconomic factors, Rick also needs to look at global macroeconomic factors that influence the automobile industrybefore deciding whether he should expand his plant’s scale of operations.As compared to the U.S. where the automobile industry is mature, the automobile industry in many emerging economies is still in infancy and, thus, presents the greatest growth opportunities to global automobile companies including Detroit’ Big Three which are Ford, GM, and Chrysler. U.S. has already been taken over by China as the world’s largest automobile market (CNBC). China has a growing middle class which presents great opportunity for foreign brands that tend to have more prestige as compared to local automobile brands. Thus, it is not a surprise that local Chinese automobile companies have been losing share to foreign competition from Europe, American, and Korean manufacturers (Kai, 2014). It is quite likely that American automobile manufacturers will continue to push aggressively into emerging economies like China and India where the future growth primarily lie.

These are some of the most exciting times for the automobile industry because not only growth prospects are bright in emerging economies but even U.S. auto sales are expected to rise in the near future. The U.S. automakers are also benefitting from the fact that the global growth in the automobile sector is primarily being led by light vehicles which is not surprising given the fact that there is emerging middle class in emerging economies where most of the growth now comes from. In 2012, more than half of the light vehicles sold occurred in China, Brazil, India and Easter Europe. Of the top four largest markets for light vehicles in the year 2020, only one will be developed market, i.e. U.S. The other three are expected to be China, India, and Brazil( J.D. Power and Associates, 2013). The strong performance of the U.S. automobile sector has not gone unnoticed by Standard & Poor’s which has raised the ratings for Ford and GM (Standard & Poor’s, 2013).

It is important to think of the automobile industry as truly a global industry, with almost every major player operating in several markets and U.S. automakers are no exception. Fortunately, almost all of the important U.S. macroeconomic indicators are headed in the right direction but even if some were not, Rick can still make the case for as long as international factors are encouraging which is actually the case. IMF expects emerging economies to grow at at least 5 percent annual growth rate in the coming years and populations in emerging economies are enjoying increasingly higher levels of disposable income (Akhtar, 2013).

Even if the U.S. economy may still be in recovery mode, the U.S. automakers have not been resting on their laurels. Ford expects to increase its global production capacity by one-third by 2017. The company is also building new factories in India and China (Seetharaman, 2013). Similarly, GM has also been focusing most of its efforts on emerging economies and hopes to increase its share in India to 4.5 percent by early 2020s which is almost twice the company’s current market share in India (Murphy & Watts, 2014).

Conclusion and Recommendation

The recent financial crisis was the worst ever since the Great Depression and it is only natural for the U.S. economy to take years to fully recover. The recovery is still in progress though the country has come a long way. U.S. economy has benefitted from sound monetary and fiscal policies which have included low tax rates on consumers, increased government spending in the wake of the financial crisis, and low interest rates that encourage borrowing by both consumers and businesses. Inflation rate is still at relatively acceptable level and unemployment rate has significantly come down though it still has a way to go down before Fed is comfortable. All of these bode well for the U.S. automobile though favorable macroeconomic factors in the U.S. are only one part of the equation, due to the global nature of the automobile industry. Fortunately, international indicators are also encouraging. Emerging economies offer huge growth potential and U.S. automakers have strong position in markets like India and China. In addition, U.S. companies have also been working on expanding their production capacities.

It is clear that both national and international macroeconomic indicators are quite encouraging and, thus, Rick should go proceed with his plans to expand scale of operations. IMF expects emerging economies to grow at 5 percent at least per year in the coming years and emerging economies are still in infancy in terms of car ownership as compared to developed markets like the U.S. China is already the world’s largest automobile market and it will not be surprising if India also overtakes U.S. in the coming decades. Even in the U.S. automobile sales are expected to increase which should not be surprise, given the expected improvement in national economy. Even if national indicators were less encouraging, international prospects alone may have justified Rick investing in added production capacity but fortunately both national and international prospects look bright.

References

J.D. Power and Associates. (2013, September 25). The Global Auto Industry’s Balance Of Power Shifts To Emerging Markets. Credit Week, pp. 13-18. Print.

Akhtar, T. (2013, September 27). Emerging markets as a key source of income. Retrieved August 12, 2014. Web.

CNBC. (n.d.). World’s 10 Largest Auto Markets. Retrieved August 11, 2014. Web.

Coinnews Media Group LLC. (2014). Current US Inflation Rates: 2004-2014. Retrieved August 11, 2014. Web.

Davidson, P. (2014, July 30). Economy heats up in Q2 after harsh winter. Retrieved August 11, 2014. Web.

Elliott, L., & Chon, W.-L. (2008, Augut 14). Economy: US inflation jumps to 5.6% but may have peaked. Retrieved August 11, 2014. Web.

Federal Reserve Bank of New York. (2014). Federal Funds Data. Retrieved August 02, 2014. Web.

Federal Reserve Bank of New York. (n.d.). Historical Changes of the Target Federal Funds and Discount Rates. Retrieved August 11, 2014. Web.

Greenstone, M., & Looney, A. (2012, November 2). How Does Our Economic Future Compare with That of 2008? A Glimpse at America’s Road to Recovery. Retrieved December 1, 2013. Web.

Igan, D. (2013, July 30). U.S. Fiscal Policy: A Tough Balancing Act. Retrieved August 11, 2014. Web.

Isidore, C. (2008, December 1). It’s official: Recession since Dec. ’07. Retrieved August 11, 2014. Web.

Kai, P. (2014, August 12). Chinese domestic auto brands lose market share. Retrieved August 12, 2014. Web.

Marr, C., & Frentz, N. (2014, April 15). Federal Income Taxes on Middle-Income Families Remain Near Historic Lows. Retrieved August 11, 2014. Web.

Murphy, C., & Watts, J. M. (2014, August 11). GM to Jump Start International Operations. Retrieved August 12, 2014. Web.

Paletta, D., Ng, S., & Hilsenrath, J. (2008, September 18). Worst Crisis Since ’30s, With No End Yet in Sight. Retrieved August 11, 2014. Web.

Schneider, H., & Flaherty, M. (2014, April 30). Fed shows faith in U.S. economy with bond-buying reduction. Retrieved August 11, 2014. Web.

Seetharaman, D. (2013, October 7). Ford targets one-third increase in capacity within five years. Retrieved August 12, 2014. Web.

Standard & Poor’s. (2013, September 25). Ratings Update. Credit Week, pp. 32-35. Print.

The Department of the Treasury. (2012, May). Recent U.S. Economic Growth in Charts. Retrieved August 11, 2014. Web.

The Heritage Foundation. (2014). United States. Retrieved August 11, 2014. Web.

Willis, B. (2009, March 6). U.S. Economy: Unemployment Rate Increases to 8.1% (Update2). Retrieved August 11, 2014. Web.

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