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The Recession of 2008-9 Was Deep and Long Since the Great Depression of 1929-32
It has been argued by several economists that loose monetary and fiscal policy lead to great depression in the economies. Money was kept too cheap and easily accessible for a long time in the critical years leading up to 2005. The consumption of the domestic markets exceeded productions which lead to an increase in borrowing in the economy. The Exchange rates of the US/UK currencies were strong making goods and services expensive especially in the international market. Therefore, made import of commodities exceptionally high than exports in the period preceding 2008-9. The recession of the US/UK economies led to a slowdown of economies and put the financial status of the nations at risk. The fiscal policy was expansionary and the expenditure exceeded taxation revenue resulting in government deficits With an aim of avoiding further mistakes made by the policy makers in the past, many governments in the world reacted to the situation by easing the monetary policy, implementing the discretionary fiscal policy and injecting more money in the form of credit into the financial market and nationalizing banks (US Treasury, 2011).
However, the response of various economies differed from one to another depending on the economy’s magnitude and capacity. World Bank estimates that the Great Recession of 2008-2009 led to a rise in poverty to 64 million people by 2010.Therefore, the food and oil crisis was and still is a major concern especially for the developing countries. The diagram below describes the major factors that contributed to the Great depression (2008-9).
How to Use Fiscal Policy to Encourage Recovery from Recession
Fiscal Policy is the use of Government spending, taxation and associated borrowing to influence the level of economic activity. It can be used in an economy to prevent inflation and avoid recession. In the case of a recession, an expansionary or loose fiscal Policy can be applied in order to increase Aggregate demand (AD) which is the total level of planned expenditure in an economy. The government will increase spending and cut taxes. This will eventually translate to more consumer spending and disposable income. Therefore, improving and increasing economic growth. Government may also choose to employ discretionary fiscal policy to reinforce these effects.
In implementing a further discretionary fiscal policy, the domestic purchasing power of the economy will be increased. This can done by reduction of Value Added Tax rates among others in order to reduce prices of domestic commodities hence increase business activity in the market.
Limitations of the Fiscal Policy
However, there are many limitations of using fiscal policy. The government can employ discretionary fiscal policy to reduce the effects of the recession by reduction of tax rates especially on domestic products to make them affordable and accessible. However, on the other hand, the government’s expenditure bills and deficit may increase against revenue from taxes collected. This normally leads to deferring of payments to a future date and Balance of Payments Current Account deficit in the Gross Domestic Product (Araujo et al, 2011).
Consequently, fiscal policies such as taxation take longer to organize and implement. Spending plans are only set once a year. These may lead to delay in implementing changes to spending patterns. In addition, the effectiveness of the expansionary fiscal policy depends on other factors such as consumer confidence. If consumer confidence is very low, the effects of tax cuts may not be felt in the economy. Poor information can also cause the fiscal policy to be ineffective or act vice versa to the intended reaction. A wrong prediction of recession can lead to unpredictable and unplanned inflation. Moreover, government spending may mean selling of bonds and borrowing of money. If this occurs, then it will reduce private consumption and investment, thus reducing the size of the private sector. Finally, it is believed that the private sector spends money more efficiently than the government, thus, if the government spends more in an economy than the private sector, it is believed that it will lead to decline economy welfare.
How to Use Conventional Monetary Policy to Encourage Recovery from the Recession
Monetary policy is the process by which the government, central bank, or monetary authority of a country control money supply and availability, and the cost of money or interest rate to achieve a set of objectives aimed at the growth and stability of an economy. Conventionary monetary policy refers to the main monetary policies used to influence an economy to an intended state. There are a variety of tools used to influence the outcome of economic growth, inflation, unemployment and exchange rates with other currencies.
The policy can take a contractory or expansionary form. For an economy to recover from a recession the expansionary monetary policy is implemented to increase money supply in the domestic market and an accommodative interest rate applied to enhance easy access to funds for development, increase consumers spending and economic activities (Riley, 2006).
Consider the Limitations on the Use of Conventional Monetary Policy in These Circumstances
Conventional monetary policy is limited in the sense that it cannot be applied if interest rates are at or close to 0% and still there remain deflation concerns or deflation is already occurring.
When the economy is in a recession, conventional monetary policy may be ineffective in increasing spending and income. This is because it does not affect the demand side of an economy but affects only the supply side. Supply of more money in to an economy does not necessarily mean that there will be equivalent amount of demand.
The recent financial crises make it clear that the conventional monetary policy cannot be used to bring back financial stability and economic recovery.
Explain What Unconventional Monetary Policy has been Used and How This was Supposed to Work
Unconventional monetary policy refers to other monetary policies used particularly when interest rates are at or close to 0% and there are deflation concerns in an economy. Unconventional measures that can be adopted include Credit easing, Quantitative easing and Signaling. Credit easing, involve the central bank in purchasing private sector assets, in order to improve liquidity and improve the accessibility of credit. On the other hand, signaling is used o lower market sentiments of the future interest rates. For instance, in the 2008 crisis in the US economy, the Federal Reserve Bank anticipated that interest rates would be low for a long period of time (Federal Reserve, 2012). The Quantitative measure targets to increase private lending and borrowing by the reduction of long term rate of interest and increase of money supply.
Both the US and UK economy have used Quantitative easing measure to make government borrowing accessible and affordable As a result, both governments have been able fund their deficits at very low interest rates.
What are Supply Side Policies? Consider the Contribution These May Make to Resolve Our Current Economic Problems
Supply side economics refers to the economics aimed at improving the capacity of an economy. Therefore supply side policies are attempts by the government to increase productivity of an economy and shift Aggregate supply (AS) to the right as shown in the diagram 1 below.
Supply side policies are aimed at increasing the efficiency of the free market and reducing government interventions. If supply side policies are implement these can lead to several benefits.
Firstly, inflation will decrease because the shifting of the aggregate supply (AS) to the right means that our economy will become more efficient in terms of production causing supply side policies to reduce cost push inflation and increase economic growth.
Consequently, as a result, unemployment capacity in our economy will decrease, since these policies can assist in reduction of structural, frictional and real wage unemployment. Such as reduction of state welfare benefits and trade union power.
Moreover, our Balance of Payments Current Account Deficit can also decrease due to improved efficiency and productivity of our domestic market firms therefore raising the level of commodities exported. Examples of such measures include regulation of the labour market and financial markets to increase competitiveness and lowering tariff barriers to encourage trade activities. This measures will increase competition among the domestic market firms that will lead to lower prices and better quality of goods and services rendered.
Response to Recession by Various Economies
There have been more similarities in approaches use in the recession period by US,UK & Euro Zone. Firstly, in the US economy, the current government which is the conservative – Liberal coalition government decided to encourage less spending rather than increasing taxes. This was done by injecting $150 billion in to the economy to increase government expenditure into the US economy to facilitate health care, tax reliefs and infrastructure projects. They opted not to change the discretionary stance of the fiscal policy. The previous government employed the expansionary fiscal policy by reducing VAT from 17.5% to 15.0 %, with an aim of tightening it when economic conditions changed for the better. However, they did not come back to power.
Subsequently, in the Euro Zone, the fiscal policy is maintained as it is neutral and they plan to tighten it as soon as their economies enter a recovery path. In the UK, several supply side policies to curb unemployment and activate economic growth have been employed. This has been achieved through regulation of the labour market, reduction of the trade unions power, equipping and empowering the unemployed population with work skills and reduction of income tax. This has lead to a low unemployment rate in the years 1993-2007 and also sustainment of a long period of economic growth.
In conclusion, all the three economies names US, UK and Euro Zone, had their monetary policy very close to Zero thus very low. The Monetary policy was instrumental in gearing the economies into an economic crisis, therefore not implemented this time round.
Diverse Effects Resulting from Implementation of Policies by the US, UK & Euro Zone
The impact by the above actions as regards to implementation of the fiscal policy is that;
In the US economy, there will be more available funds for development purposes and improvement of lifestyle regardless of the fact that there is a recession. Basic commodities will be more affordable and available for the domestic market until the economy recovers. Consequently, in the Euro Zone there will be a reduction of the BOPCA deficit and other debts. In the UK economy, implementation of supply side policies has lead to low unemployment and a long period of economic growth.
However, in all the regions the monetary policy used worked to their disadvantage. Therefore, it has to be maintained at it is so that to allow other policies to be implemented effectively.
Assess the Political Pressures and Social Issues That Might Constrain Governments from Following a Purely ‘Economic Solution’ to Their Most Pressing Macroeconomic Problems
All governments intervene through their macroeconomic policies in achieving certain policy objectives and improve the overall performance of the economy. The government economic policies target to sustain economic growth and sustainable position on the balance of payments, stabilise prices, maintain low unemployment & a high standard of living and sustain sound government finances. In their endeavouring to do so, they may be constrained from following a purely economic solution to their most pressing macro economic problems.
These factors include inaccurate economic data which is unreliable because it consists of data collected from tax returns and survey. Such data are inaccurate since data does not remain constant all the time. Secondly, conflicting policy objectives are normally experienced. For instance, a policy used to stimulate aggregate demand and reduce unemployment, can cause the Current account of the balance of payments to increase. Therefore, it is always a trade – off between the fiscal and monetary policy. The government has to decide which risk they can bear in their endeavours to stabilise the economy. In addition, economists have varied views regarding fiscal and monetary policies. Choosing the right instrument to use has to be done carefully to effectively meet certain objectives. Subsequently, there is uncertainty in time realisation of policy employed. This is because changes in economic policies are subject to uncertain time lags. Consequently, External shocks may adversely affect macroeconomic policies employed. These unexpected occurrences include rapid volatility in exchange rates and commodity prices such as Fuel and Oil prices, unexpected events such as earthquakes and September 11th 2001 event. The effect of these occurrences may be exaggerated or under-estimated by the governments and therefore apply too little or too much of a policy response.
In addition, there are other factors that may affect the implementation of the most efficient economic solutions. Political stability is essential for any economy for flourish. A country where there is constant instability for instance, civil war and other factors, the economy of such a country is affected negatively and adversely. In addition, desire for immediate results by politicians as well as selfish ambitions may hinder the implementation of the most efficient policy. Consequently, poor political governance can constrain an excellent economic solution. Thus, lead to low domestic and international Consumer confidence and Investor confidence reducing the effect of macroeconomic policy measures to boost an economy.