United States Crisis of Year 2008
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The United States crisis of the year 2008 was the most severe as its effects were experienced all over the world. The crisis was a major blow to the country and no other major crisis had ever been experienced in the country since the Great Depression of the 1930’s. The losses were estimated to range about $945 billion in the United States only but if the loss were to be estimated all over the world, it would range to trillions of money (Kilmister, 2008). The effect of the crisis started around the year 2005-06 but the effects were only felt on September 2008. The major reasons that led to such a crisis could be attributed to the collapse of top investment firms such as the Lehman Brothers, Bears Stern, Merill Lynch and the Citi Group (Reinhart & Rogoff, 2009). The collapse of such institutions was a blow to the economy, which not only stagnated but also led to the collapse of the economy.
Fiscal and monetary policies are some of the aspects that countries like the United Kingdom employed in solving some of the pertinent issues that affected 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 helps 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).
Monetary and fiscal policies work in a countercyclical manner. Both their impacts when introduced are felt for a short term but once they are withdrawn, the expected outcomes on growth and employment disappear. Monetary policy helps to stimulate growth and employment temporarily leading to a higher risk of high inflation, which usually needs to be controlled through a monetary tightening. This involves devising a method of keeping inflation at a low, stable level to avoid deflation. Such a policy aims at reducing unemployment levels and boosting growth but all these usually have a huge cost to the economy. If inflation were to increase, it would increase the interest rates since lenders and buyers would require adapting themselves in the drop of the purchasing power of money (Morgan, 2011). A crisis as the one experienced in the United States could lead to a drop in the prices of commodities, which consequently would lead to high rates of unemployment.
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 would shoot quite high and this would have a negative effect on the economy, as zero interest rates would not be 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).
Fiscal policy usually has a short-term effect towards the expected outcome. It enhances the outcomes of a stable economic growth and employment and facilitates stabilizing the private sector and especially when its demand is slow so as to reduce debt. Fiscal stimulus works by cutting on taxes as well as huge government spending in order to produce high levels of growth in the economy. However, this is effective only in the short run, as withdrawal of such an impulse would lead to the disappearance of the intended outcome. If a country is experiencing high levels of debt, then introduction of a fiscal policy would make the public aware of high future taxes leading them to purchasing more than what they invest. Consequently, a country might opt to withdraw such a policy resulting in lower growth. Additionally, this tends to increase the levels of unemployment in the short run. To avert such instances, cuts on spending could be introduced as this would facilitate the financial institutions to still provide more money to the public to avoid increase in inflation rates.
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. The sole aim would be for a lower and steadier inflation. 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 would too increase leading to inflation. Additionally, they could incorporate the use of tax rebates whereby money would be delivered to households who in return through advice would 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. The most effective action that the president could take would be by cutting on spending and reducing the tax expenditures to facilitate financing of the lower tax rates. As a result, this would reduce the debt to GDP ratio, which would be a boost to the interest rates. Therefore, it is important to note that the government and the Federal Reserve are the major players in controlling the growth and decline of the economy. Their sole responsibility is to protect the public rights especially those in real estate businesses so that they can encourage them to invest more. More investments would mean more growth and more job opportunities, which would avert the incidences of unemployment levels. Moreover, it would help control the rising costs on commodities ensuring that goods and services are accessible to all persons equally regardless of their class levels.
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 would increase as the interest rate increase. This has a drastic effect on the fiscal policy such that the high taxes would 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 would be expanding, then the debt to GDP ratio would fall. All these would affect both the fiscal and monetary policies, as the interest rates would increase a budget deficit. However, the lower the debt to GDP ratio, then the healthier a country’s fiscal outlook is. It is thus important to keep in mind that a country’s economy cannot be controlled solely by one policy. It requires the intervention of more than one policy in order to achieve the required results.
The crisis that was experienced in the United States was one that had severe and drastic effects, both on the public and the private sector. The outcome left so many people with huge losses of which some were beyond repair. The United States therefore had to revive the economy through a disbursement of about $700 billion, which was intended for the public for purposes of investment. The crisis could be explained in three dimensions, which were crucial as they depicted the extent through which the damage had occurred. One of the most important aspects was that there was an increase in debt both in the corporate and household sectors. However, the damage was more in the household sector since during the period, many persons had resulted to acquiring of mortgages to build houses and most of them lacked any form of securities. Secondly, there arose an international instability in monetary funding whereby the rest of the countries in the world refused to offer any financial funding to the United States. Lastly, this led to an ecological crisis on the world economy.
The 2008 crisis in the United States was caused by an increase for the debt that had been assumed by consumers as well as 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 debts. As a result, the government opted to use the monetary policy to solve the crisis through an increase in rebates to the public which 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 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 would result to saving more money thus reducing the aggregate savings because consumption and investment would be low. When aggregate supply curve shifts outwards, there is reduction in output. This contradicts in the fact that if more workers would be willing to take wage cuts, then the price level would decrease 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.
Most of the experts and economists have argued that the best cause of the financial crisis that was experienced in the United States in the year 2008 could be attributed to the sub-prime loans. These kinds of loans lacked any form of security as they were administered to persons who lacked jobs or any other form of assets or incomes. Moreover, immigrants were also qualified for the loans and thus this was a threat to the economy as it would be difficult for such people to repay back the money. A good example of a high-risk loan that contributed to the crisis is the Adjustable Rate Mortgage. This kind of loan allowed the borrowers to only, pay back the interest offered on the loan but not the principal amount thus leading to huge losses. There was overbuilding of houses since the public had access to money causing the prices of homes to decline during the beginning of the summer in 2006. In addition, the period of March, 2008 saw about 8.8 million homeowners possess a negative or zero equity, which increased the rate of inflation in the economy (Bianco, 2008).
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. The government could have first planned for their action and especially, before they introduced the rebates. This would have helped them come up with measures that would control how the public was investing the money they were offering. Such control measures would have ensured that at least the public took it upon themselves to invest part of the money thereby reducing the rising costs of inflation. 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. The policies that it put in place helped solve the crisis not only for short-term basis but also for long term as they would never want a repeat of such a crisis.
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. The Federal Reserve’s concern was to manage the monetary policy with total disregard of the housing bubble. It is therefore a lesson that a growing economy is usually the result of an incorporation of all aspects that can have an influence whether in the positive or negative manner. The rise in the prices of homes was due to the fact that, the Federal Reserve had earlier on in the decade lowered the interest rates. This had consequently helped the public to have the power to purchase as many homes as they wanted. It is therefore quite important for the government to plan for such adversities to avoid dealing with them on an ad hoc basis. This can reduce the calamities that face a government especially when it has a huge budget deficit and the donors are less than willing to help with finances. What happened to the United States should never be allowed to happen again and it’s a duty for all countries to put measures that avert such occurrences.