The stability and vigor of any economy is very important to individuals living within that country, especially when it comes to determining prices of items, employment and lending interest rates. The economy usually undergoes different business cycles; these cycles include either a period of expansion (boom) or a period of contraction, which is referred to as the recession (Weaver 1).
These economic convulsions normally occur in the ordinary course of business and they are usually unpredictable. Some of the most famous economic contractions to ever hit the planet were the great depression of the 1930’s in U.S.A, the Asian currency crises of the late 1990’s and lately the great Recession of Dec 2008-June 09.
The long term growth of any economy is usually controlled by the government using both fiscal and monetary policies. These two tools are known as Macroeconomic policies which the government manipulates over the long run and short run in order to ensure that the economy achieves optimal performance (Colander 29).
Monetary policies aim to control the supply of money and interest rates within the economy by setting a floor or ceiling on the amount of money supplied at the economy at any one given moment (Weaver 17).
Fiscal policies on the other hand is a macroeconomic tool which a government steers the path of the economy by fluctuation the levels of government expenditure and revenue election which is also known as taxation. Both monetary and fiscal policies are important tools that enable the government through economists to carefully plan on how to counter the negative effects of either a recession or economic contraction.
The Great Recession
The great recession of 2008-09 is considered to be the worst recession that hit the American economy since World War II, furthermore the fact that the American economy was entering into recession was scaring the rest of the world’s biggest economies and trade partners this wide spread panic threatening to lead to a financial contagion.
The beginnings of the effects of the recession were felt in the Q1 (first quarter) of 2008 whereby by March over 63,000 Americans did lose their jobs. In Q3 the effects of the recession were rampant and many businesses around America started closing down due to bankruptcy claims, at the same time the American public spending had plummeted by over 6.3% and the economy of the United States Gross domestic product went down by 0.5%.
In the same Q3 of 2008 more that 156,000 American had lost their jobs (Roberts 29-40). During March 2009 the full effects of the recession were seen worldwide with America’s closest allies and business partners facing the hit and having their economies also plunge into economies contractions. During the same time the American unemployment rate had hit 8.5% and close to 5.1% million Americans were now jobless (Auerbach 6).
This meant that America was now in a lot of trouble because the Citizens were less liquid and had little or no money to spend, the same applied to businesses and not only were small to mid level commercial enterprises affected by this but also the giant business now felt the hit and their quarterly earnings together with share prices went down. Some of these corporations included A.I.G insurance, GM General Motors, Lehman Brothers, and Bear Stearns.
When citizens and businesses of an economy do not spend due to luck of enough disposable income then speculation ceases to exist and an economy which does not spend will definitely not grow but shrink (Roberts 79-82). The American government was forced to intervene because it could no longer sit by and watch the economic prowess of their country go down the drain the government used Macroeconomic policies to restore the public and investor confidence in the American Economy by bringing it back to track.
The Government comes to the rescue
The American government through the Federal Reserve decided to introduce a $ 787 billion stimulus package as a part of its fiscal policy to stimulate spending within the American economy. The American government aimed at increasing the amount of money which was in the hands of Americans.
By this way then Americans would have more money to spend on goods and services within their borders. Most of the money from the package leaked and trickled down into the economy through unemployment benefits for those who lost their jobs and other social welfare provisions and domestic expenditure in education, health care, and infrastructure together with the energy sector (Auerbach 1).
According to Maynard Keynes, a renowned economist, when the government counters the contraction of an economy during a recession, increased government expenditure can be a way by which the government can increase aggregate demand within the economy.
An increase of funds in the economy will mean that there are more funds which individuals can use to purchase goods within the American economy, this way even the business men and entrepreneurs together with corporate establishments will also have more need to increase business activities and order more suppliers from other vendors.
In other words the spending and demand of goods and services as a result of increase government spending will encourage repeated economic activity that will send a shock wave through the economy and revive business activities (Auerbach 3).
The expansionary monetary policy which is also called by economists as easy money was brought about by the Barrack Obama’s administration in order to ensure that local American bushiness would no loner close down because the American consumers lacked funds to stimulate demand, the economists under this regime believed that increased expenditure as the result of the fiscal policy would end up increasing the amount of money that the American public held and this would force them to demand goods and services.
Another fiscal policy adopted by the American government during this period was reduction of taxes especially through tax incentives which were also designed for both individuals and companies.
Under this scheme, individuals would either save on taxes as a result of tax cuts or receive government cheques of tax incentives. Some of this tax benefits and incentives included new payroll tax incentives where individual taxation was reduced in homesteads that increasing the amount of money available to individuals once they were paid (Auerbach 6).
The government reviewed Expansion of child tax credit by extending $1,000 credit to families with children even those families which were not able to pay taxes before. At the same period families with children in collage also got tax incentives in order to promote spending in education, home buyers also got tax incentives through the Homebuyer credit scheme where the government wanted to encourage individuals to buy homes and revive the real estate sector.
Unemployed individuals who were enjoying unemployment benefits had their taxable income coming from unemployment benefits also reduced (Roberts 172-177). The government also extended tax incentives to individuals who used more friendly sources of energy and building materials in their homes.
Companies on the other hand were allowed to adjust loses running up to five previous years and file for tax refunds, tax credits were also extended to companies which have adopted renewable energy and green practices and some companies also got tax credits and refunds through adjusting the depreciation of their assets.
The move of the American government to offer tax incentive to both the corporate world and individuals was to increase the amount of disposable income in their hands in order to elevate aggregate demand within the American economy.
When the great recession hit America, the government was forced to carry out radical monetary policies in order to pull out the economy out of the recession. The economic bubble that came with the recession interrupted the demand and supply of money together with interest rates.
The subsequent contraction of the economy forced the Federal Reserve to adopt an expansionary economic policy that would enable the cash tight economy ensures that the supply of money in the economy was appropriate for recovery. The government besides initiating a $787b went further to bail out banks which had lost numerous funds and had even run out of capital to cater to the largest deposits of their customers (Roberts 82).
The rapid revival of the economy meant that the Federal Bank initiated a nationwide response that would guarantee the increase in supply of money and this would decrease the interest rates. The recession made it hard even for individual and companies to borrow credit because the shortage of money meant that the cost of borrowing had gone up and this led the entire nation to a liquidity problem and individuals/corporate did not spend a lot of money because they feared borrowing.
The government thus introduced a bail out package of $ 700B, this bailout plan was necessary and proved fruitful because most of the time it is the banks which serve as the financial intermediaries in a country’s financial system to control the amount of the money in the economy and this provided an avenue by which the Federal Reserve could regulate the supply of money within the economy (Roberts 254).
By this way, the Federal Reserve would easily control or influence the interest rates and encourage the American public to borrow money from the American Banking system, thus the individuals would spend the money in recurrent expenditures and speculation and encourage growth of the economy.
The net effect of this bailout would be stabilization of prices and interest rates, this way business and economic activities would increase steadily and this would reduce unemployment rates in the long run through encouraging repeated expenditure which will push companies into employing more individuals in order to expand their business.
The moves made by the American government and the Federal reserve contributed a lot towards ensuring that the American economy recovered from the recession more quickly and less scathed. Had the government not reacted as first as it did and used the available macroeconomic policies to bring the expansion effect in the economy at the time of the contraction, then not only would America be affected but the effects of the recession would have been even harder on other countries of the world.
Auerbach, Alan. “Fiscal policy in recession: US fiscal policy in Recession: what’s next?” CESifo Forum 2/2009. 2009. Web. 8th June 2011.
Colander, David. Macroeconomics, 8th Edition. New York: McGraw-Hill, 2009. Print.
Roberts, Michael. The Great Recession. New York: Lulu Enterprises Inc., 2009. Print.
Weaver, Frederick. Economic literacy: basic economics with an attitude. Maryland: Rowman & Littlefield Publishers, 2007. Print.