Causes and Origination of the Crisis
There is more than a single factor that have been confirmed to be responsible for causing the GFC. This paper will determine where the GFC originated from, it will identify the factors responsible for its origination. The GFC is believed to have originated from one nation and spread to all other nations since the world economies are closely interconnected by globalization. This recession is believed to have had the greatest impact on most economies. There are only a few economies in the world that felt the least impacts of the GFC. Most economies are still suffering from the impacts that resulted since the GFC took place. This paper will also note the world economies that felt the least sway during the period 2007 to 2009 when the recession came to an end. The policies implemented by these nations will be identified and analyzed to determine their effectiveness. If these policies proof to have been more effective in containing the situation, they will be used as policy recommendations against any poor performance in the economy, and may be used in any developed or developing economy.
This paper will therefore be useful in determining the most effective policy. Thus, policy makers will be mostly interested in understanding what happened, and what proved to be the best policies. With this information, the policy makers will be able to enhance their policy implements and decide effectively what is good for different conditions. In macroeconomics, there are many policies that can be employed by the government or its central bank to improve performance during the period when the economy’s health tend to be poor. The two most important policies are the fiscal ones where government directly influence the economy through lowering of tax rate or an increment in its expenditure. The other main policies are the monetary policies where the central bank stimulates the economy by lowering the interest rate or raising the supply of money. During the GFC period, governments employed these policies in one way or the other. The paper will determine why specific policies were chooses and their effectiveness. The paper will also determine whether the policies employed are effective in the short are only effective in the long run.
Economic recession is the falling in the Gross domestic product (GDP) for two successive quarters. This means than an economy is reporting a negative economic growth rate during this period. The major reason why recessions occur is because consumers and businesses losses their confidence on the state of the economy. A lower confidence means that demand also contracts (Kolb, 2010). Consumers are noted to respond to the lost confidence by moving into a more defensive mode and postpone spending. As a result, panic sets in; this is especially when a large number of consumers go to the defensive mode. Due to this, there is a significant fall in retail sales discouraging businesses from production, thus, fewer jobs are created. When manufacturers note that their product are facing a low demand, they decide to lower production and some workers end up jobless; the unemployment rate surges. The confidence can only be restored through the stepping in of the Federal government.
The Consequences on the US Economy
According to Amadeo (2018), the deregulation of financial industry was the primary factor behind the emergence of the crisis. The deregulation had permitted banks to trade in derivatives by hedging of funds. The sales of these derivatives were more profitable which left the banks with increased demand for mortgages to facilitate the trading. Sub-prime borrower were able to obtain loans since the banks had introduced interest-loans only. John (2010) pointed out that the banks were greedy in their lending and that’s why they carried out uninformed lending practices. The interest rate on the mortgages rest earlier in 2004 causing the Fed rate to be revised upward by the Federal Reserve. The supply for houses outpaced the demand thus causing a fall in the housing prices (Guina, 2017). The homeowners suffered as they were not able to afford the payments anymore and they ended up being trapped since they couldn’t sell their houses (Friedman, 2011). The raising of the interest rate by the Fed created a very bad situation for the homeowners and can be greatly accused of causing the bursting of the housing bubble. The value of the derivatives later started falling which made the banks to impose restrictions against lending to each other. This is what caused the 2008 crisis.
Before the crisis, the housing prices in the US were going up and investor had great expectations that this was going to continue (Positivemoney.org, 2018). Therefore, they end up buying unaffordable houses so as to benefit from the expected benefits (Claessens & International Monetary Fund, 2014). The real cause on the housing bubble was the low interest rate that existed in the US in 2004 and 2005. The interest-loans only enabled subprime borrower to buy houses so that they may only resell them later at a profit (Shiller, 2012). The bubble started bursting in 2006 when a great decline in the housing prices was reported. Many homeowners were in a great panic and feared making great losses by selling at a price lower than what they had spent on buying the houses (Farlow, 2013). This led to foreclose which in turn raised panic on the banks and other hedge-funds which were already making great losses from investment in the secondary market.
In 19th September 2008, the crisis intensified. The money that banks advance credits to businesses and other short term loans was greatly reduced and firms removed the money they had in their bank accounts and opted to move them to less risky investments such as treasury bonds. The money they removed from their accounts was equivalent to $140 billion.
The US economy was severely impacted in that $5 trillion were wiped from the system (Iyer, 2017). These fund were for pensions, real estate value, 401k, etc. the number of people who lost their homes were 6 million with 8.8 million left unemployed. The initial mortgage meltdown ended up getting the US into a recession which was harmful as it slowed down the economy; businesses were not able to expand anymore; others ended up closing down. When banks were noted to have solvency issues, clients were not willing to hold their money in banks accounts anymore. This forced many people to make huge withdrawals from banks to avoid the heightened risks of loss. Eventually the US economy was on a credit crisis; this is what deepened the GFC. There were massive injections into the banking system by the Federal Reserve but this did not prevent lending from falling.
A very important consequence which was provided by Kelleher (2012) was on the weakening of the US monetary and fiscal capacities. In an effort to control the crisis, trillions of taxpayers’ money was used up. This left the US economy at a bad position just in case there was a future crisis. The US annual budget deficit exceeded $1.2 trillion. Tressel (2016) also noted a change in the capital structure for firms. Firms were not willing to leverage themselves by longer term debts and there was a significant decline. The US economic model was delegitimized as an impact of the crisis (Kirshner, 2015). Initially, the US economy was believed to be immune to crises as it was the least impacted while all other economies were hit. However the 2008 crisis undermined the belief about its immunity.
According to A&E Television Networks (2018), the stock market in the US had reached its all-time high peak as at 9th October 2007. The industrial average according to Dow Jones exceeded 14,000 which was the first in the US history. This was the last good news for the US economy as over the next one and half year, Dow dropped to 6,547 points; this was more than a half dropped. Many American who had life saving in this stock market fell into catastrophic financial losses.
The following is the macroeconomic variable that were greatly impacted in the US.
Fig 1: The US Real GDP
The US real GDP fell significantly during the crisis period as observed in the graph. However, the rising trend shows that the US was able to completely move from the crisis
Fig 2: The US real GDP growth
The real GDP growth rate for this economy was negative during the crisis, this is the worst economic growth in the US history. The recovery was sufficient considering the high positive real GDP growth reported in 2010.
Fig 3: The US unemployment Rate
The unemployment rate formed a peak in the US during the crisis. This is an indicator that there was a massive loss of jobs; millions of people were left with no income and this is responsible for the inadequacy of demand for goods and services and the reduced retail sales. Iyer (2017) noted that the actual number of jobs lost were 8.8 million. The graph show that the US was not able to create more jobs upon recovery but have greatly improved over the years. It has taken many years for this economy to get to the current low unemployment rate which is equivalent to that of 2006 before the crisis took place.
Fig 4: The US total investment (% of GDP)
Before the crisis, the US’s total investment (% of GDP) was very high. The investment started falling before the crisis and reached its lowest trough in 2009. Upon recovery, the US economy was not able to boost its total investment to the initial level; the total investment are still low up-to-date and this explains why the creation of jobs have been low.
Fig 5: The US general Expenditure
The government expenditure rose during the crisis. This was as a result of the stimulus package response that the government introduced. Ever since the crisis, the US expenditure is on a rise.
The US economy started its action as soon as it discovered the economy was contracting. Since the interest rate was the first factor to blame, the Fed started by lowering the target interest rate. As at September 2007, the interest rate were 5.25%, but as the year 2008 was ending, the target interest rate had been reduced to 0%. This was a historical reduction aimed at stimulating the economy by encouraging people to borrow more and thus raising the investment level. This government’s initial response did not work out and the government was forced to implement alternative policies. Lowering of the interest rate did not stimulate the economy during the crisis and thus can be said to be a long-term policy other than a short one.
There are several policies that the US government employed in attempting to limit the recession. The pumping of liquidity by the Federal Reserve began in 2007. Term Auction Facility was the medium in which liquidity was pumped into the banking system. This action by the Fed was not enough as many investors in March 2008 went after Bear Stearns one of the greatest investment banks. The rumors of it having many toxic assets was circulating. This created a need for Bear to seek a bail out from JP Morgan Chase. The bank guaranteed $30 billion to sweeten the deal. This brought some thought on the Wall Street that the panic was no more. However, through the 2008 summer, the situation deteriorated. This forced the Congress to authorize the bail out of Fannie Mae and Freddie Mac mortgage companies by the Treasury Department. $85 billion were used by the Fed in bailing out AIG. This rose to $150 billion in October.
The Economic Stimulus Act was signed into law by President George W. Bush in February 2008. This legislation was beneficial as it advanced tax rebates to the tax payers ($600 to $1200). Spending was encouraged, taxes were reduced, and loan limits were increased for federal home loan program (A&E Television Networks, 2018).
Upon deliberation between The Fed Chair Ben Bernanke and Henry Paulson the treasury secretary, the bailout package of $700 billion was submitted to the congress. This fast response gave some confidence to businesses such that they kept money in their bank accounts. The bill was however no passed immediately; it was blocked for two weeks by the Republicans. They were not willing to bail out the banks. The bill was delayed in improvement until the collapsing of the global stock market nearly took place. The treasury department used $350 billion to buy the low price bank and automotive company stocks. The taxpayer therefore did not incur the $700 billion. The other $350 billion were never used as it was meant for president Obama. Instead, he tossed an economic stimulus package of $787 billion. This unlike the other liquidity pumping into the banks was meant to directly stimulate the economy. The money was sufficient such that in July 2009, the financial crisis came to an end.
In 2010, President Obama signed into law the Dodd-Frank Act. This was designed because the US government had been initially limited power over its financial industry. The Act was meant to ensure there was at least some restoration on such power. The ACT enabled the government to take control of banks that were about to collapse. It was also design to incorporate consumer protections on their investments. Banks were restricted from lending to borrowers with no history of credit repayment. The old administration policy was not well modelled as it limited the government’s power over the financial institutions; further, it failed to protect the investments made on stocks.
The US economy initially had failed to be successful in reducing the impacts of the crisis because it relied on monetary policies. From this paper, the monetary policies have been found to be ineffective during a case of emergency and thus, they should only be used for long term stimulation. On the other hand, I would recommend the use of fiscal policies as they can be very effective to boost aggregate demand in the short run. An example is the case of Australia where households were given relieve money by the government during the Christmas period; this gradually boosted retail sale. Thus, even when employing the policies, the government should first determine the appropriate time to do so.
Conclusion
The economy was severely hurt and it incurred many consequences. The US government mostly relied on monetary policy to influence the economy. The paper shows the many instances where the Federal Reserve raised its supply of money. The target interest rate was lowered to zero leaving no room for more expansionary monetary policy in case the crisis never came to an end. According to the research carried out, it can be argued that the monetary policy was the least effective policies during the crisis. Fiscal policy can be argued to be the most effective policy. This can be confirmed that the $ 787 billion stimulus package that was the 2nd stimulus package meant for tax cuts and spending on infrastructure, health care, schools and green energy ended the financial crisis in the US. Fiscal policies are effective in the short run and monetary policy on the long run. If am running the Fed, I would determine the policy mix that would expand the economy while still raising the interest rate to ensure than the economy is well set to deal with future crisis.
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