United States Crisis of Year 2008

Date: Nov 3, 2017

Crisis of Year 2008

Fiscal and monetary policies are some of the aspects that countries like the United Kingdom employ in solving some of the pertinent issues that affect the country’s economy. Such issues include a high unemployment rate, an inflation rate of about 2% per year, an almost zero interest rate and a GDP growth rate of less than 2% per year. Both of the policies’ aims are to reduce the rate of fluctuation in the economy. A fiscal policy employs the aspects of increasing government spending which consequently lead to a huge budget deficit while cutting on taxation rates. However, the monetary policy involves a change in demand and supply of money, which incorporates the use of interest rates. Moreover, it can incorporate other aspects such as open market operations (Bivens, 2004). All these work towards reducing inflation to improve a country’s economy.

The use of a fiscal policy help lower a huge budget deficit as it involves an increase in taxes, which consequently lowers government spending. This kind of policy would be applicable more especially in the United Kingdom but this is not the case as it would be difficult to reduce government spending due to its effect on public services. On the other hand, a monetary policy would work by raising interest rates, which has an adverse effect on the exchange rate of a country. Consequently, the exporters of such a country and homeowners with various mortgage payments would be drastically affected. On the other hand, high interest rates would mean huge profits for the savers who would access a higher income. It is therefore important to note that the effect of a monetary policy is not the same throughout a country’s economy since both borrowers and savers would be affected differently (Reinhart & Rogoff, 2009).

Curb Inflation

In order to curb inflation and improve interest rates, a monetary policy could be used to enhance spending and promote more people into investing in real businesses. In addition, this would weaken the rates of exchange leading to more exports and more income. However, such a case might have drastic negative effects and especially when the financing institutions lack sufficient credit for lending, if they lack confidence in the borrowers and more so when house prices fall. When house prices fall, the interest rates shoot quite high and this has a negative effect on the economy, as zero interest rates are not sufficient to improve the economy of a country. Okun’s law states clearly that low unemployment results in a higher national output, which in itself is unrealistic. On the other hand, the Philip’s curve perceives that unemployment and inflation have an inverse relationship (Ben S, 2007).

It is therefore quite difficult to place both unemployment and inflation rates low since this is the exact opposite of what the Philip’s curve depicts. It tends to imply that as more people work, the national output is increased. This leads to an increase in wages, consumers have more money to spend and therefore the demand for goods and services increases. The Federal Reserve has the sole responsibility of controlling inflation through use of the contractionary monetary policy. As the chairman, one of the ways through which one would implement this is would be by tightening the money supply such that there is a specific amount of money required in the market. As a result, economic growth and demand would slow down reducing pressure on prices of commodities (Bivens, 2004). This is done especially when the GDP growth rate exceeds the ideal 2-3%. Another solution would be controlling the amount of money required in banks at the end of the day such that the money in circulation would be reduced.

As the president of a country facing high unemployment rates and zero interest rates, the first action to take would be to analyze the growth rate of the country for the past few years to be able to know the rate of inflation and how to curb it. This could be done by use of an aggregate demand curve whereby in the long term, the prices of commodities would be high and growth would eventually lower to a level that the economy can sustain. Moreover, the aggregate supply curve reveals that as growth increases, the prices of commodities increase too leading to inflation.  Additionally, they could incorporate the use of tax rebates whereby money is delivered to households who in return are advised to invest it leading to an increase in GDP growth rate. Multiplier and the tax multiplier is another way through which the economic growth of a country could be improved (Ben S, 2007). This works by the notion that an increase in taxes would lead to a reduction in total government spending consequently lowering the GDP. However, an increase in government spending would lead to an increase in total spending and consequently increasing GDP.

A High Debt

A high debt to GDP ratio and a growing budget deficit has its own dangers to the economy of a country such that the more the government adds to the national debt through a budget deficit, the more the payment interest rates increase. The amount of money that needs to be paid will increase as the interest rate increase. This has a drastic effect on the fiscal policy such that the high taxes will lower spending leading to a reduced budget deficit. Moreover, if the state borrows less relative to the size of the economy than the rate at which the economy expands, then the debt to GDP ratio would fall. All these have effects on both the fiscal and monetary policies as the interest rates increases a budget deficit. However, the lower the debt to GDP ratio, then the healthier a country’s fiscal outlook is.

The 2008 crisis in the United States was caused by an increase for the debt that had been assumed by consumers as well as the excessive advantage of banks and other financial institutions. As a result, there was an increase in ‘sub-prime’ loans whereby loans were made to person’s who lacked a down payment on the home to be financed as well as having poor credit ratings. Many homeowners were able to get home equity loans to pay their mortgages, which led to huge debt. As a result, the government opted to use the monetary policy to solve the crisis, which was only effective in the short run but not in the long run. The monetary policy to increase rebates to the public did nothing but worsen the economy as few people invested the money many opting to pay off their debts. This was further deteriorated when government sponsored enterprises like the Fannie Mae and Freddie Mac who were encouraged to buy more mortgages including the risky sub-prime mortgages (Bivens, 2004). In the end, the situation could not be contained causing the government to use the fiscal policy to solve the crisis.

The Fiscal Policy

The fiscal policy had to deal with a few consequences caused by the upward sloping of the aggregate demand curve, which would cause interest rates to fall to zero. When this happens, individuals result to saving more money thus reducing the aggregate savings because consumption and investment is low. When aggregate supply shifts outwards, there is reduction in output. This contradicts in the fact that if more workers are willing to take wage cuts, then the price level decreases leading to an increase in unemployment than if the workers were less willing to take wage cuts. This policy argues that the government should be ready to assume more debt to allow the private sector to steady itself. In the short term, the policy worked to curb these issues but only its long-term effects were able to solve the crisis to levels that the economy could sustain itself.

On a personal opinion, the government intervention before the crisis did more harm than after because it encouraged financial institutions to lend more money without any securities. However, its intervention after the crisis ensured that the economy was at a level that it could sustain itself thus helping solve the crisis that was facing the United States. If I were to find myself in the same situation, I would have done the same since I would be helping persons from all class levels to sustain themselves. However, the government should plan for such adversities to avoid dealing with them on an ad hoc basis.

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