The rise and Fall of American Economics - Term Paper Example

? The Rise and Fall of American Economics Introduction The term economy refers to the structure of the economic life or economic activity in a particular community, region, nation, a group of regions or countries, or the entire world. Macroeconomics involves the overall performance of a particular economy. Various parameters are used in measuring economy, which include the number of people working, their total income or their production/the amount produced. The common-most parameter is gross product, which measures the market value of the produced final goods and services in a region under focus/a particular geographical region over a specific duration, usually one year. In this study where the focus is the United States’ economy, we consider the U.S. gross domestic product (GDP), which measures the market value of the entire final goods and services produced over a given period (normally one year) in the United States. One can use the GDP to either compare a variety of economies over a given period, or to track a particular economy over a desired period of time. In this paper, the GDP of the United States will be useful in tracking her economy over time in efforts to evaluate the rise and fall of her economy (Krugman & Wells, 2009). Considering that macroeconomics characteristically focuses on a nation’s economic performance including the manner in which the nation’s economy interacts with other economies globally, it is worth noting that the economy of the United States is not only the largest but also the most complex in the world history, with 87,600 separate government jurisdictions, approximately a hundred and fifteen million households, and thirty million profit organizations/businesses. The U.S. economy is therefore comprised of millions of decision makers who though acting with some autonomy, are all linked with the entire economy. The economy is dynamic – keeps continually renewing itself with new businesses, customers, foreign competitors, households and public official groups among others. Currency circulates throughout the U.S. economy, which facilitates the exchange of products as well as resources among the individual economic units – it is constantly in a circular flow (McEachern, 2008). Historically, just like other industrial market economies, the economy of the United States has gone through sporadic contraction and expansion periods. The rise and fall of the economy refer to the economic fluctuations relative to the economy’s long term growth tendency. These variations/business cycles vary in intensity and length, although some elements are universal to all. Usually, the fluctuations involve the whole nation and frequently several other world economies. Additionally, the fluctuations affect almost every economic activity dimension – not just employment and production (Hirschey, 2009). McEachern (2008) notes that the simplest way of comprehending the business cycle is by exploring its elements. He explains that in the 1920s and 1930s, the national Bureau of Economic research director carried out an analysis of business cycles and identified two phases of the economy namely “contractions” and “expansions.” He elucidated that the output of the economy declines during a contraction while it increases during an expansion. Prior to WWII, a contraction occurred – this was as severe as to be termed a depression. A depression is a sharp decline in the entire production of the nation going for over a year and accompanied by high rates of unemployment. When a contraction is milder, it is reffered to as a recession – characterized by a reduction in overall output over a period of at least six months or two consecutive quarters. Unlike prior to the world war II when the United States experienced both depressions and recessions, in the period after and until the year 2008, there have not been depressions; only recessions, which is an indication of an improved economy. The quarter-century after World War II appears more like a golden age for the economy of United States. In fact, the performance of this economy baffled the cynics whose expectations were a return to the Depression. Over this period, the U.S. economy experienced five recessions, although they were short and moderate. From 1948 to 1973, unemployment varied between 3 and 7 percent, and civilian jobs increased from 57 to 82 million. There was a surge of prices following the lifting of wartime controls after which inflation rate was contained below six percent annually until 1973 when OPEC struck (Tobin, 1988). Analysts at NEBR have made efforts to track the economy of the U.S. back to 1854. They have found out that since then, this country has experienced what they call ‘peak-to-through-to-pick’ cycles that add up to thirty two. From their analysis, they established that no two cycles have been exactly alike. While expansions and contractions averaged twenty-nine months and twenty-one months respectively over the twenty two business cycles before the year 1945, during the ten cycles over the period between 1945 and 2007, expansions stretched almost twice as long to fifty seven months and recessions decreased by half to ten months. Evidently, these developments have been greatly advantageous for the United States’ economic growth as well as for increased living standards for her residents. It is also important to note that the longest contraction on record was between 1873 and 1879 (lasted for five and a half years) while the longest expansion was between 1991 and 2001 (lasted for ten years) (McEachern, 2008). Looking at the decade prior to the aforementioned longest expansion period in the history of the United States’ economy, that is the period dated 1980s, many things happened to the economy in question. The national leaders of that time had their focus and efforts on the demand and supply, two of the principle forces that determine any given economy. For instance, the federal government lowered taxes in 1981 with an aim of increasing labor supply as well as that of other resources, an approach they termed as the supply-side approach. The advocates of this approach believed that an expansion of real GDP (expansion in employment and output) and a reduction in price level would result from increase in aggregate supply, but this was not easy to achieve. Unfortunately, recession hit in 1981 even before the tax cut took effect resulting into contraction of output in addition to an increase in the rate of unemployment to ten percent. Following the end of this recession, the U.S. economy started growing again and the country experienced this growth continuously for a decade (Tobin, 1988). Undesirably, during this period of flourishing economy, the increase in federal spending superseded the growth in federal tax revenues, culminating into the swelling of the federal budget deficits. Moreover, with the onset of a recession in the year 1990, her deficits worsened topping two hundred and nighty billion dollars in the year 1992, although that recession had officially subsided by the end of March 1991 (Taylor, 2006). In 1990, the then President, George H. W. Bush raised taxes in efforts to reduce federal deficits that had accumulated an enormous federal debt. Additionally, in 1993, President William Clinton raised tax rates for the highest ranking in tax bracket, and a newly-elected Republican Congress slackened the growth in federal expenditure in the year 1995. Alongside an improving economy, the deliberate move of slackening the growth of federal expenditure in addition to the increase in tax rates made the federal budget to turn into a surplus by the year 1998. The United States’ economic expansion by early 2001 became the longest on record. It is worth noting that during this stretch, not only was there an addition of twenty-two million jobs in the U.S. reducing the rate of unemployment from 7.5% to 4.2%, but also the inflation remained modest. After having received this longest stretch/expansion on record, the U.S. economy slipped into a recession. The September 2001 terrorist attacks in the U.S. heightened this recession. Although this recession did not last long (it lasted only 8 months), the economy underwent a very slow and uneven recovery, with the rate of unemployment escalating incessantly, reaching a peak at 6.3% in June 2003 (Olivia, 2008). With an aim of ‘getting the economy on move again’, President George W. Bush pushed through tax cuts. However, the tax cuts as well as federal expenditure boosted its deficits, which went above four hundred billion dollars in the year 2004. Although employment was not growing, output was, owing to the fact that those who had jobs became more productive. Surprisingly, in the late 2003, the economy of the U.S. started adding jobs in spite of uncertainties that the Iraq war created as well as higher prices of oil and it had added eight million jobs by mid-2007 (McEachern, 2008). Although the economy of the United States has been through ups and downs, over the long term, it has registered a dramatic growth. McEachern (2008) documents that by the end of the year 2007; this economy was producing over thirteen times more output as compared to what it did in the year 1929. Among others, this dramatic rise in production is attributable to betterment of/advancement in technology that has been in use in the U.S. over the period in focus; increased quality and quantity of resources, especially capital and labor; and improved policies that facilitate exchange and production, which include patent laws, legal system, property rights as well as market practices. In the year 2008, the United States experienced a financial crisis brought about by the nation’s housing bubble-burst, which negatively impinged on the her economic growth. Because of its nature many people measure up this crisis to the 1929 great depression (Shah, p2). The United States’ financial crisis was marked by the fact that there was a breakdown in several major financial institutions. Additionally, the nation experienced an unusual drop of a range of stock markets. Furthermore, the US experienced a dramatic expansion of spreads on diverse loan varieties over equivalent treasury securities. According to the financial press and policymakers, the nation experienced a rapid reduction in nonfinancial corporations’ commercial paper issuance. They also point out that rates rose to unequaled levels and banks’ lending to nonfinancial corporations and individuals declined sharply. Moreover, in essence, interbank lending ceased existing in the US (Chari, Christiano & Kehoe, 2008). Some analysts placed the blame on bad loaning practices that gave rise to subprime loans and connected risks’ wholesale universal spreading via intricate toxic trash -derived financial tools for kindling the crisis. Others censured the absence of regulatory controls/political intervention for promoting low-interest rates that brought about otherwise wavering economic situation that would have been served better by a succession of minor market-cycle corrections (Kritayanavaj, 2008). According to Spiegel and Rose (2009), the financial crisis had its roots in the historically greatest credit and housing bubble. Several parties/players including brokers as well as mortgage lenders, borrowers, investment banks, investors, securities and credit rating agencies, financial innovators, issuers and dealers, regulators as well as financial insurers et cetera were concerned. Housing has been an incessant major United States’ economy growth contributor. Previously, housing growth always made a positive contribution to the society’s well-being, overall consumption, as well as employment. An intricate and extended succession of causes and outcomes brought about the financial crisis. For over a decade, housing prices rose successively attracting housing speculators and extending a thriving market. A great number of mortgage lenders began practicing reckless lending through giving sub-prime loans that they sold in the secondary mortgage market for securitization. Hopeful of a higher return, they also traded to investors numerous mortgage backed securities along with other innovative and sophisticated sub prime loans-backed debt products. By way of elevated credit ratings, rating agencies reinforced confidence in these generally complicated mortgage securities as well as those who dispensed them. In consequence of the great demand for these intricate investments, a slackening of lending standards occurred, which encouraged more loans. Consequently, house prices augmented and fuelled a greater housing market bubble (Kritayanavaj, 2008). It is thereby clear that the 2008 US’ housing market bubble-burst was as a result of over a decade of housing boom, which rose steeply into an absolute worldwide economic and fiscal meltdown. Many banks, throughout the boom, raised their leverage through dispensing and ultimately holding more of the intricate mortgage securities. Quick profits motivated them, making them engage in very risky risk-management endeavors. Towards this boom’s closing stages, granting unqualified purchasers dubious sub-prime loans made the bubble bigger at the outset and eventually led to the most recent global economic crisis (Kritayanavaj, 2008). The financial crisis reached its peak from August-October of the year 2008. Several key financial institutions that had great attachment to real-estate lending either went bankrupt or were sold for pennies. Prices and trading volumes of mortgage-backed securities considerably attenuated. In addition, lending disinclination extended to other markets and the economy of the United States went into a long slump (White, 2009). The US experienced a radical fall in share prices, the nation’s financial market’s volatility rose to levels that had in no way occurred and bank and corporate borrowing cost rose significantly. The drop in new loans to large corporations increased during this peak period of the financial crisis. New loans were 36% less compared to the preceding three months. In October 2008, the fall was principally great. There was a fall in productive investment lending, lending for leveraged buyouts over and above a fall in mergers and acquisitions. While non-investment grade lending fell by 50% investment grade lending dropped by 19% percent. In the same way, term loans declined by 26% while revolving credit facilities declined by 39%. In September, the banking sector’s health brought about much concern and there was banking panic and in October, the world governments had to get involved (Ivashina & Scharfstein, 2008). Kritayanavaj (2008) explains that this economic crisis led to a worldwide banking and financial markets’ weakening as well as the weakening of the overall US economy as well as that of other upcoming markets. To date, the US as well as many other developed economies is experiencing economic decline and probable broken cycles. Conclusion Apparently, the United States’ economy has undergone sporadic contraction and expansion periods the fluctuations have involved the entire nation and often, several other world economies. Of all the crises, the 2008 financial crisis proved to be the worst. Due to global interdependence, almost every nation experienced it. Additionally, being the world’s largest economy, any slowdown arising from the economy of the US unavoidably spreads to other nations. Although the US and other world countries are yet to recover completely from this economic recession, it is important to note that despite its ups and downs, over the long run, the economy of the United States has not only been an incredible creator of employment and output, but is also the world’s most productive economy. There are questions regarding the way in which America should manage her undercapitalized banks and, in particular, the way in which the government can come up with a future financial system that will be more resistant to undesirable shocks. It is important to note that with financial stimulus in position and no possibility of more, fiscal policy by the Treasury as well as the Fed is the only effective option for further feat of counterbalancing the downturn. References Chari, V.V., Christiano, L. & Kehoe, P.J. (2008). Facts and Myths about the Financial Crisis of 2008. Retrieved from http://www.minneapolisfed.org/research/WP/WP666.pdf Hirschey, M. (2009). Fundamentals of Managerial Economics. Stamford, Connecticut: Cengage Learning. Ivashina, V. & Scharfstein, D. (2008). Bank Lending During the Financial Crisis of 2008. Retrieved from http://www.people.hbs.edu/dscharfstein/Lending_During_the_Crisis.pdf Kritayanavaj, B. (2008).Global Financial Crisis 2008: A View from Thailand. Retrieved from http://www.ghb.co.th/en/Journal/Vol4/36.pdf Krugman, P. & Wells, R. (2009). Macroeconomics. London: Macmillan. McEachern, W. A. (2008). Economics: A Contemporary Introduction. Stamford, Connecticut: Cengage Learning. Olivia, A. J. (2008). The Impact of the 9/11 Terrorist Attacks on the US Economy. Journal of 911 Studies, Vol.1. Shah, A. (2008). Global Financial Crisis. Retrieved from http://www.globalissues.org/article/768/global-financial-crisis Spiegel, M.M. & Rose, A.K. (2009). Searching for International Contagion in the 2008 Financial Crisis. Retrieved from http://www.voxeu.org/index.php?q=node/4043 Taylor, J. (2006). Principles of Macroeconomics. Stamford, Connecticut: Cengage Learning. Tobin, J. (1988). The Rise and Fall of the American Economy. Cambridge: MIT Press. White, LH. (2009). Housing Finance and the 2008 Financial Crisis. Retrieved from http://www.downsizinggovernment.org/hud/housing-finance-2008-financial-crisis Read More