Market Government: The Recession in the USA - Assignment Example

Market government Introduction to the Issue The Recession that has taken place in the US in the period 2007-09 is of a much different nature compared to that of the other phases of recession that the world witnessed. The huge amount of reduction in the output as well as the income of the people is due the fall in the input that was being put by the labor market in the economy. There was a very huge rate of unemployment in the economy. The decline in the level of employment in the country during the phase was extremely steep. Various economists put forward various thoughts regarding the causes of recession. However the generally accepted view points out to the housing bubble to be the prime reason. It all started with the collapse of Lehman Brothers and quickly penetrated into the market causing turbulence and system crash. This recession did not take place as a result of a business cycle that generally affects each and every economy. A number of reasons underlie this particular case of financial crisis including that of the shocks arising in the general business cycles which has been instrumental in disrupting the labor market equilibrium in the United States. The entire issue of the financial crisis is to be reviewed from all the angles of economics including the neoclassical, mixed liberal and the radical points of view to have a perspective of the entire event. This paper will enlighten the various perspectives put forward by the different schools of thoughts and accordingly place their views in the following paragraphs. Application of the Neo-Classical Theory to the Issue The Neo Classical economists base their theories on the microeconomic principles which include the optimization of the individuals and firms and to determine the equilibrium price and output in the economy using the market forces of demand and supply. The theory considers that the people make rational decisions based on the information that they have about the market. The neoclassical economists explain the fluctuations in the economies as a result of the upturn of the business cycles in the economy (Blanchard, 2000). The economic variables that generally behave in a particular fashion in order to result in a recession have behaved in a most unusual manner in case of this particular financial crisis. The level of consumption, output investment as well as the employment of labor was much low. By analysis of the economic variables it was found that the crisis of the present period is much more severe compared to that of the Great Depression of 1937 or any other recessions that have taken place in the world. The drop in the level of investment during this time was also about 33.5%. On the other hand the level of consumption experienced a decline of more than 5.4%. The main reason that was found to cause the great recession was the fall in the values of the mortgage backed securities. The failure of the major financial institutions like Lehman Brothers, Fannie Mae, and Freddie Mac etc were also the major reason for the commencement of the crisis at that point of time. The financial intermediation services declined drastically during this time. This is because the TED spreads were rising very steadily during this time. These events triggered the level of imperfections in the economy to a large extent. This included the worsening of the bottom-line of most of the manufacturing and services sectors of the country. There was a decline in the aggregate demand in the economy due to the shortage of cash and hence the level of output in the economy declined. US experienced a decline in the level of investment and hence the rate of unemployment in the economy went down. Hence labor market distortion is one of the major reasons why the economy faced these dire consequences. The data that have come out of the analyses of the economists and practitioners have proved that the labor market was more badly hit due to this particular crisis as compared to the capital markets. Hence the shocks that the economy of US faced occurred more due to the real variables. The cyclical distortions as well as the shocks in the labor market productivity led to situation the country was into. Therefore from the neoclassical point of view most the financial crisis of 2007-09 was a result of the shocks in the business cycles including the deviations from the general equilibrium condition of the labor markets. Since the US economy has a very large labor market compared to the other nations of the world such deviations have proved to have a magnifying effect on the entire economy. Application of the Mixed Liberal Theory to the Issue The financial crisis has often been perceived from the point of view of the Neo Liberal economists. The reason for the crisis has been cited as the global imbalances as well as the Debt crisis that had been happening especially in the emerging nations of the world. As opposed to the Keynesian school of thought the mixed liberalist school of economics believes that the economic decisions are taken by individuals rather than in a collective fashion. This school of thought supports the market economy with little or no government intervention. These economists encourage the possession of the private properties by individuals. The role of the state according to the liberal school of thought should be confined to providing public goods only. From the point of view of the liberalist school therefore the crisis took place in US because the principles of liberalism acted at its peak. From the point of view of the liberal school of thought the crisis took place because of a host of reasons. The major banks and the financial institutions of the country failed as a result of the rise in the popularity of the derivatives market. The debt level of the country was rising with the lack of government intervention into the system. The Federal Reserve subsequently undertook the quantitative easing policies which were done to increase the supply of money in the economy. This kind of intervention on the part of the central bank was to counteract the money market of the United States. A large number of multinational organizations also tried to evade the taxes which are as a result of following a free liberal mixed economic set up and the organizations are mainly capitalistic in nature. There were malpractices in the free capital markets which resulted in this kind of crisis in US. The Libor exchange rates in the finance industry are market determined. The attempt of speculators to manipulate such rates has resulted in the fraudulent activities which required the interventions on part of the government. Due to the free markets there have been cases of insider trading which has affected the common people of the country. The globalization in the equity or derivatives market has also accentuated a problem of this sort. The intervention of the government thus had to be brought in to bring the situation of chaos under control. Since the entire economy is market driven and the individuals involved in the equity markets are extremely short sighted there was lack of foresightedness in the activities of the financial institutions and the investors. There were various kinds of fraudulent activities like rate fixing and dealing with high risk derivatives instruments like Credit Default swap. Application of Radical theory to the Issue The radical economic school of considers that the market economy is responsible for destroying the economic environment. Since this school believes that the competitive forces are responsible for exploitation of the labor forces in the economy. As a result there is increase in the level of unemployment in the economy. This is turn would result in the increase in the imbalance in the distribution of income in the society leading to a polarized world. Therefore the radical school of economics is based on the leftist school of thought and the underlying principles are based on the theories put forward by the Marxist school of thought. During the 1970s the economy of US experienced a profit crisis by most of the enterprises. There was a trend of negative profit in most of the countries of the world. The attempts of globalization and increase in the trade activities were undertaken in the economy in order to combat this gap in the levels of profit in the economy. From the radical point of view, the intension of increasing the level of profit by the firms of the capitalist economy have resulted in such a kind of crisis and increase in the level of unemployment in the economy. The wages of the labor in the US economy had stagnated and adding to it the level of debt burden of each of the people in the economy was on the rise. The debt arose out of the purchases of houses, cars or even the basic requirements by the individuals in the economy. The debt of the households had increased by more than 130% in the time of the financial crisis. The capitalism of the country continued to increase with the increase in the levels of debt by both the households as well as the firms. The crisis heightened at the bursting of such debt bubble. In the theory of Marx such cases of debt can extend the phase of boom, but would eventually lead to a depression which would turn out worse than it could be thought of. Thus the crisis started with the suppression of the level of wages in the economy and ended up being a household debt crisis and took an unmanageable form. Hence according the Marxist school of thought the crisis took place when a host of factors led to larger problem which became magnified with time. The changes in the policies of the government of US may also be attributed to being also one of the causes of the crisis. The high levels of debt that the banks have may lead to the failure of the banks. The transition of the market based profit oriented capitalist structure to the socialist structure with necessary government regulations may only be a useful long term solution for US. Conclusion The discussion above proves that the financial crisis took place due to a number of reasons. Each of the pillars has its respective explanation for the cause of this situation of crisis in the United States. It has been found that the lack of government intervention in the market based economy like the US was the reason why so many fraudulent activities took place and the need for a control from a regulatory body was immensely felt. Thus the Liberal point of view of the theory considers it to be the main reason for the occurrence of the crisis. On the other hand, from the neoclassical point of view the shock in the business cycle has resulted in this economic situation. Finally the radical school analyses the reasons for the crisis from the leftist point of view. Each of the explanations is right in its own way. References Blanchard, O. (2000). Macroeconomics. Englewood Cliffs: Prentice Hall. Read More