The Great Recession
A recession is a period marked by reduced economic activity. In their article “The effectiveness of fiscal and monetary stimulus in depressions” Almunia et al. describe several serious conditions present in a recession. They say that a recession exhibits “an environment of near-zero interest rates, dysfunctional banking systems and heightened risk aversion that had not been fully exploited” (2009).
If the economic activity of a nation were to be plotted in a graph, the trend line would exhibit a pattern of peaks and troughs. The peaks represent increased economic activity known in economics as expansions while the troughs represent reduced economic activity better known in economics as contractions.
Between the years 2008 and 2009, the US economy and the world at large experienced one of the severest recessions in modern history. Important events according to the BBC recession timeline were: “HSBC warning of subprime losses in early 2007, credit market freeze in August 2007, Lehman Brothers going bankrupt in September 2008, Fed cutting key rate to near zero and the US congress passing a $787 billion stimulus in 2009.” (BBC News, 2010)
One of the causes for the great recession was “regulatory failure” (Weisberg 2010). Analysts blame then-Fed chairman Alan Greenspan for “keeping the interest rates too low between 2003 and 2005” (Weisberg 2010). It is during this period when the “real-estate bubble inflated spurring a frenzy of irresponsible borrowing. [When the bubble burst in 2007, it left in its wake a] … high rate of defaults on subprime mortgages” (Weisberg 2010).
There are three approaches that a government can take to get out of a recession: implement monetary policies, tackle the recession using fiscal policies or use both monetary and fiscal policies.
Macro-economic policies experience time lags. For example, according to the article 12.3 Issues in Fiscal Policies (Anonymous, 2010), there was a “recognition lag” concerning the great recession when it informs that “the current recession was not identified until October 2008 when the Business Cycle Dating Committee of the National Bureau of Economic Research announce that it had begun in December 2007” (2010).
The same article also talks about the “implementation lag” (Anonymous, 2010). This can be taken to be the time it took the Obama government to agree on what monetary and fiscal policies to employ. Lastly, the article talks about the “impact lag” (Anonymous, 2010) which is the time the macro-economic policies will take for their full impact to be felt. Already the economy is limping out of recession, but it will take longer than the theoretical projections that policymakers made on paper.
Fiscal policy
McTaggart et al define fiscal policy as “the use of the nation’s budget to achieve full employment, sustained economic growth and price level stability” (2007 p.24). When an economy is in a recession its central bank executes an expansionary fiscal policy that involves an “increase in government expenditures on goods and services and cutting of taxes” (McTaggart, 2007 p.596).
Some of the fiscal policy-related interventions undertaken by the Obama administration included: a temporary tax, an extension of the employment benefits by “providing the unemployed with benefits that could push a laid off person for 99 days” (Burtless 2010), and as Burtless states “subsidies for unemployed persons so that they could pay for health insurance” (2010). “Federal grants were also dished out as fiscal relief to state government. This money ended up paying for law enforcement cost and education” (Burtless 2010).
Monetary policy
The Fed is the sole issuer of money in the economy. It can therefore directly influence the amount of money circulating in the economy. The Fed uses the cash rate as a monetary policy instrument. The cash rate “is the interest rate on interbank loans. In a recession for example the objective of the Federal Reserve Bank would be to increase economic activity. To achieve this it reduces the cash rate. This makes it cheaper for banks to hold large reserves for transactions. This reduced interest rate will be transferred to borrowers. It is the borrowers who use the cash in economic activity that increases the real GDP.
The goal of the US government monetary policy as prescribed in a 1977 amendment to the Federal Reserve Act is “to promote maximum sustainable output and employment and to promote “stable” prices” (Federal Reserve Bank of San Francisco, 2010).
Short-run effects of macroeconomic policy
Quoting a communiqué from the Pittsburg G20 summit Jackson says that the short-run state of affairs after implementation of both monetary and fiscal policies can be summed up as “it worked” (2010).
Jackson recommends that “interest rates should remain low” (2010). Additional effects of the US monetary policy can already be seen. Jackson reports that the “ultra low interest rates and major injections of liquidity into the banking system are already fueling new financial asset price bubbles” (2010).
Koo (2010) mentions a peculiar short-run problem that the US economy is now facing. After an active monetary policy by the Fed to bring the economy out of the great recession: “The US economy is now facing a balance sheet recession a rare disease that strikes only after the bursting of a nationwide debt-financed asset price bubble.” The only way out of this, Koo adds, is for the Fed to “inject capital into banks to end the credit crunch” (2010) this can be done through a fiscal policy.
Long-run effects of macroeconomic policy
Jackson advocates for “the US Fed to run productive fiscal deficits to ensure the impact of low interest rates is felt through higher public investments.” He adds that “Labour intensive public investments like transit and passenger rail are ideal because good public infrastructure and good public services are key drivers of private sector productivity” (2010)
One opponent of fiscal policy asserts as follows: “it is confirmed that in the long run, expansionary fiscal policies are not beneficial to economy generally” (Kukk, 2010). On the contrary, Jack points out that “in the short term, low interest rates make viable a huge raft of potential public and environmental investments which will more than pay for themselves over time” (2010). Taking a firm stand on the supply side of the macro-economic debate Jack reasons that:
“In the longer term, a decade and more of expensive and wasteful tax cuts mainly in favour of corporations and those with high incomes means that there is humble room to increase government fiscal capacity to balance budgets without cutting spending and without undermining living standards of working people” (2010).
Conclusion
Contrary to a pessimistic view held by some about “Obama’s stimulus package,” Burtless feels that though imperfect, it deserves a great deal of credit for bringing [the economy] back to a positive trajectory” (2010). The economy is slowly rising out of recession. It is understandable that getting out of a severe recession especially one of the worst in US history is not an overnight affair.
To close the recessionary gap ambitious monetary and fiscal policy measures had to be implemented. This required the Fed to reduce the cash rates. Ultra-low interest rates were meant to produce a ripple effect that would see other interest rates fall; this would make the exchange rate of the US dollar fall. Due to fallen interest rates “the quantities of money loans and credit would increase consequently consumption, investment and net exports would increase” (McTaggart, 2007). This would increase autonomous income in the hands of firms and Americans.
A fiscal policy related to public investment has the effect of leaving firms and Americans with extra income on their hands which is referred to as autonomous expenditure. Since the taxes imposed on firms and workers have been checked, the firms get an incentive to produce more to replenish their inventories to the levels they had before the recession. Spending this autonomous income triggers off the multiplier and the expected outcome is an amplified change in equilibrium expenditure which serves to increase real GDP to equal potential GDP thus eradicating the recession.
McTaggart gives the assurance that if the two macro-economic policy interventions “are timed correctly, and [are] of the correct magnitude,” (2007, p.596) it is possible to restore the economy to pre-recession level.
Works Cited
Anonymous: 12.3. Issues in Fiscal Policy: 2010.
Almunia, Miguel et al. “The Effectiveness of Fiscal and Monetary Stimulus in Depressions.” VOX: Research-based policy analysis and commentary from leading economists. 2010.
BBC News. “Global Recession Timeline,” 2010.
Burtless, Gary, “The Success of Obama’s Stimulus Program,” Crisis No More. 2010.
Federal Reserve Bank of San Francisco, US Monetary Policy: The Fed’s Goals: 2010.
Jackson, Andrew. “Beyond “Stimulus”: Fiscal Policy After the Great Recession.” Global Research, 2010.
Koo, Richard. “The Fed should ask for fiscal policy support.” The Economist, 2010.
Kukk, Kalle. “Fiscal Policy Effects on Economic Growth: Short Run vs. Long Run,” Published in Working Papers in Economics. School of Economics and Business Administration, Tallinn University of Technology (TUTWPE), Pages 77-96. 2007.
McTaggart, Douglas et al. Economics. French Forest NSW, Australia. Pearson Education. 2007. Print.
Weisberg, Jacob. “What caused the Crash? Let the Bickering Begin.” Newsweek, 2010.