How the Federal Reserve Was Successful in Its Management of the Great Recession - Essay Example

The Federal Reserve was successful in its management of the “Great Recession" Introduction In times of economic strains such as depressions, countries usually undergo a lot of stress in the management of their fiscal and monetary accounts. It is quite imperative that one has appropriate measures that can cushion them against the harsh economic conditions such as those of the Great Depression. The United States of America was not any different or even spared by the Great Depression. The depression referred to in this context was that in which there was a severe economic depression worldwide at around the period that preceded the World War II. However, a near reoccurrence of the same situation took place in the year 2008 when worldwide; all nations had difficult economic situations (Berton 254). At about the Great Depression period, the rate of the Real Gross Domestic Product began to decline at a rate of about 6% annually, and the monthly average number of jobs lost rose to about 750,000. This stunning turn of events led to the stunning application of stringent fiscal and monetary policies by the Federal Reserve so as to curtail the spread of the effects. In responding to the unusually large size of the fiscal stimulus, the Federal Reserve noted that this was in consistency to the severe downturn and limited ability for the usage of interest rates nearing zero. At such hard economic times, the government of the USA through the Federal Reserve is expected to employ necessary economic variables and measures such as fiscal and monetary policies to try and resolve the situation. To this end, I can argue that the Federal Reserve was successful or effective in the manner in which it managed the Great Depression. The table below shows the annual GDP rates of the USA for the period 1910 to 1960 with the depression period lying between 1929 to 1939 (Robbins 569). This paper will strive to show how this is true and back up the arguments with relevant statistical inferences from the available corresponding economical indicators and data. Ideally, in this paper, I seek to reconsider the effectiveness in the use of fiscal policies in the wake of the recent economic crisis, and in particular in relation to the Greta Depression. As such, I will examine some of the economic policies that were advocated for and adopted by the Federal Reserve economists, as well as the specific policy measures that were undertaken by the Federal government of that period. By examining the labor market, I find it that it renders as inadequate, the contemporary approach of aggregate demand that has been mostly applied by economists at the Federal Reserve in solving the economic crisis. As such, the aggregate demand management approach was not effective in the period of Great depression to enhance the achievement of certain macroeconomic variables like the stabilization of the expectation of investors and investments, equitable distribution of income, and the generating and maintaining employment at full standards. In line with this, I will seek to review the consideration of the effectiveness of any alternative approaches to fiscal policy that could have been used towards managing the Great Depression. Therefore, in line with this investigation, I realized that the Federal Government’s commitment to the use of a labor intensive policies i.e. policies that directly target the demand gap in labor and not the gap in output, was more effective in the stabilization of the employment, investments as well as incomes of the nation during the Great Depression period. Fiscal activism during the Great Depression Most economists have been unequivocal and swift in support of the manner of fiscal activism that was employed during the period of the Great Depression. This has become as a surprise to most people aware of the events of the 1930s. While most economists had abandoned their faith in the effective use of fiscal policies to revive the nation’s economic conditions, I am glad that those at the Federal Reserve did not. Those opposed to the use of the fiscal policies were of the idea that it related much on the Ricardian Equivalence Hypothesis, which was considered dubious back then. However, through this method, the economy managed to survive the Depression as well as the economic meltdown of 2008 (Smith 346). In the reassessment of the proper role of fiscal policy in the economy today, Keynes inextricably linked the goal of a nation achieving its objective of macroeconomic stabilization to that of the attainment of full employment. According to Keynes, the principal objective of a fiscal policy should be to solve real but, fundamentally and essentially simple problems. Therefore, the adoption of the Keynesian economics by the Federal Reserve was the first key strategy that led to the mitigation of the effects of the Great Depression. This is because the Keynesian model provided for the crucial tools with which the Great Depression was dealt with, as well as adequate policies that were used to address the unemployment problem in all phases of a business that it occurred. Consequently, while the Great Depression is attributed to the sudden crash of the stock market, the Federal reserve through the fiscal policies adopted was able to mitigate on the disrupted trade, dramatic drop in credit and demand and the deflation of the prices of commodities and assets by the adoption of the conventional aggregate demand management policies. Modern fiscal policies and the Great Depression According to the conventional view of the use of fiscal policies, the contemporary economists of this period used the analogy of the ‘leaky bucket’ to explain how effective the fiscal policies could work for the government. Indeed, it worked perfectly in this occasion. First, in addressing the depression’s effects, the government increased on its spending with the sole purpose of boosting the GDP of the country. This was essential in the elimination of the unemployment problem that had rocked the country. It had to be reduced to desirable levels. However, this perspective may not be considered to have worked 100% efficiently since the fiscal policy operated on a leaky bucket did not have a direct effect on job-creation in the economy. This is in line with the Okun’s law, which states that, for every 1% increase in unemployment, an approximate 3% decline in the GDP growth rate would result. The graph below is representative of the unemployment rate trends during the Great Depression period. Source: http://www.google.co.ke/imgres?imgurl=http://4.bp.blogspot.com/_pMscxxELHEg Despite this small effect on employment as stipulated by Okun’s law, the Federal Reserve was optimistic about this strategy, and that the boosting of the aggregate demand was the most effective way to solve for unemployment during that period. The adoption of this strategy by the Federal Reserve was so that it could lower the discrepancy gap that existed between labor output and the employment opportunities in the output recession. However, as is indicated in the graph above, the rate of unemployment during the Great Depression period remained at a steady average of 15% (Gunderson 146-153). Another policy in line with fiscal policy employment was that the government had to increase its spending automatically during the depression period, with the increase in the welfare benefits, unemployment transfers and other transfers to the poor. This measure had to be made effective since the annual GDP rate plummeted to a high of 9.3% with a continued soaring of unemployment rates. According to the National Bureau of Economic Research, the Federal Reserve tried to restore confidence in the stock markets and sought to stabilize financial institutions so that the wage-employment balance could be maintained. From the table below, it is publicized that, as an end result of the fiscal policies that were adopted by the Federal Reserve, there started to be a significant increase in the investment, consumers and government purchases. The National Income Accounts for the Great Depression in the U.S. (1992 Prices) YEAR GDP CON SUMP TION INVEST MENT GOVERN MENT PUR CHASES EXPORTS IMPORTS NET EXPORTS 1929 790.9 593.9 92.4 105.4 35.6 46.3 -10.7 1930 719.7 562.1 59.8 116.2 29.4 40.3 -10.9 1931 674.0 544.9 37.6 121.2 24.4 35.2 -10.8 1932 584.3 496.1 9.9 117.1 19.1 29.2 -10.1 1933 577.3 484.8 16.4 112.8 19.2 30.4 -11.2 1934 641.1 519.0 31.5 127.3 21.4 31.1 -9.7 1935 698.4 550.9 58.0 131.3 22.6 40.7 -18.1 1936 790.0 606.9 75.5 152.5 23.7 40.2 -16.5 1937 831.5 629.7 94.0 147.0 29.9 45.3 -15.4 1938 801.2 619.5 61.3 157.8 29.6 35.2 -5.6 1939 866.5 654.0 79.5 171.8 31.2 36.9 -5.7 1940 941.2 688.0 111.3 174.2 35.4 37.8 -2.4 1941 1101.8 737.1 137.3 288.0 36.4 46.5 -10.1 1942 1308.9 719.7 72.1 692.0 23.9 42.2 -18.3 However, the decline of the Gross Domestic Product (GDP) and the rate of investment in the year 1938 soon after the depression was an indication of the recession that existed within the depression. To solve or mitigate for this, the Federal Reserve had no option but, to apply a stimulus option that greatly led to expanded growth in production extraordinarily hence, help lower the pool of unemployment that was created. Another effective measure or policy that was taken by the Federal Reserve was the full provision of liquidity to the financial institutions. This strategy was essential and effectively managed to achieve its objective from the front that economists believed that the full stabilization of the economy required the full restoration of the public confidence in the financial institutions. Therefore, the Federal Reserve employed three main tools in the restoration. These included the issue of temporary guarantees both public and private, the adoption of measures to strengthen the balance sheets of the financial institutions, and the disclosure publicly of the financial conditions of the financial institutions. By these, the money market was slightly stabilized giving rise to the easy adoption of other fiscal and monetary policies. While still within the realms of restoring public confidence on the banking system in the USA, the Federal Bank adopted stress tests and published their results. Ultimately, this measure helped in the stoppage of the acute phase of the financial crisis of the Great Depression (Smith 452). Conclusion Having stated much about the success of the Federal Reserve and the various policies that it employed in the fixing of the economy during and after the Great Depression, I would first note that the depression resulted from the immediate collapse of the private investment that was witnessed around the year 1929. The effects were an increase in the purchases of the government and unemployment rates, and a subsequent decline in exports and imports. As such, the Federal Reserve had to ensure that the Gross Domestic product was raised so as to cushion the economy from the rising pool of unemployment. The volatility in the investment during this period was due to the uncertainty that the depression caused for businesses, particularly with the nature of radical and shifting Roosevelt New Deal policies. The recovery of the economy was only seen with the advent of the Second World War, which pushed the demand for goods and services to the uttermost limits. As a current economist, thinking in the line of Keynes would imply noting that even if the Federal Reserve succeeded in the implementation of the aggregate demand concept, it did not improve as fast as was expected to help induce households and firms to start investing their funds in activities that could generate income. The reason for this was the high rate of inflation that was experienced in the depression period and the post-depression period. This is as shown in the statistical table below. YEAR PRICE INDEX RATE OF INFLATION % NOMINAL INTEREST RATE % REAL INTEREST RATE % 1929 13.12   5.85   1930 12.60 -3.96 3.59 7.87 1931 11.34 -10.00 2.64 14.04 1932 10.05 -11.38 2.73 15.92 1933 9.78 -2.96 1.73 4.54 However, the bringing to an end of the Great Depression by the Federal Reserve of the USA entailed aggressive methods of both fiscal and monetary policies. While most of these strategies are being criticized today, they are considered to have been the most effective policies during that time. On one front, the Federal Reserve employed fiscal stimulus, and on the other policies of the financial markets. To this moment, historically, the Great Depression and the financial crisis was a massive blow to the economy of the US. At that time, the unprecedented deficits depicted both the government’s costs of the multi-faceted response and a recession in itself. However, the Federal Reserve was quick to enhance economic stimulus packages that prioritized on the government spending and adopted measures of foreclosure to the economy. Works cited Berton, Pierre. The Great Depression 1929-1939. Toronto: Anchor Canada, 2001. Print. Gunderson, Cory G. The Great Depression. Edina, Minn: ABDO Pub, 2004. Internet resource. Robbins, Lionel. The Great Depression. Auburn, Ala: Ludwig von Mises Institute, 2007. Internet resource. Smith, Robert W. The Great Depression. Westminster, CA: Teacher Created Resources, 2006. Print. Read More