Cyclical Fluctuations in Aggregate Economic Activity in the United States - Essay Example

?Cyclical Fluctuations in Aggregate Economy I.Introduction Cyclical fluctuations in aggregate economic activity are now accepted as quite part of economic life with politicians describing such crisis as a necessary pain every so often. Cyclical fluctuations or more commonly known as the boom and bust cycle of the economy, was an economic reality that started with the birth of free economy. Boom is commonly understood as a period of economic growth and bust as a period of economic decline. The reality of economic growth, recession and recovery is a classic manifestation of the capitalist cycle of boom and bust. The recent US financial crisis of 2007 dubbed as great recession, to which the US is still struggling to fully recover, once more sparked debates among economists on how to avert the bust period. The paper used the US experiences ( as it is hailed as a model and leading free market economy) to present the realities and the internal laws governing recession, depression, recovery and the entire cycle of boom and bust . In the end it provided some recommendations to confront the vicious cycle of boom and bust. II.Review of Related Literature In what was considered as the biggest financial crisis in US after the Great Depression in 1930’s, it is best to look back and review the different economic theories that have either defended or criticized the prevailing free market economy. Classical economist, neo classical economist and modern day economist agrees that the cycle of boom and bust is inherent to the capitalist system of economy. They have theorized several remedies to cushion the impact of bust within the framework of the capitalist system itself. Jean Baptiste Say ,who is a proponent of aggregate supply policy, explains that there is glut or excess supply of labor and commodities because man produces what they wanted and not what others need. He further states that “It is not the abundance of money, but the abundance of other products that facilitate sales”. According to him, glut is a business problem which can be resolved through venturing into another line of production which eventually will create a new demand. Thus, glut does not mean a crisis, but rather it facilitate sales and growth. On the other hand Robert Keynes, hailed as father of modern economics and as the most influential economist of the 20th century explains that a normal circular flow of money will be achieved if people have cash on their hands. He further states that people’s? refusal to spend and resorts to money hoarding creates a liquidity trap which leads to recession and depression. As such, the government has to spend money or to “pump prime” to regulate once more the circular flow of money. Karl Marx, explained that the cycle of boom and bust is inherent to capitalist system. He provided a comprehensive critique of the capitalist system. He explained the cycle of boom and bust as a logical consequence of laws governing capitalism (Law of Surplus Value, Law of Tendency of Rate of profit to Fall, Law of Correspondence of the production in Relation to the productive Forces, Law of Accumulation and Law of Competition) (Dickhut). However, in contrast to the above economist, Marx major contribution lies in concluding that capitalism is deemed towards doomsdays. He theorized socialism as an alternative economic system not just to remedy the impact on the lives of the working class and the nation in general on the devastating effect of the boom and bust cycle but to radically eradicate it and its consequences of unemployment, inflation, recession and depression. III.Critical Analysis Great Depression The Great Depression of 1930’?s ? is widely considered by economist as a bust period. The US stock market declined by 89% (Ferguson).From August of 1929 to March 1933,the Gross Domestic Product(GDP) of US declined by 33%.Unemployment rose from 5 million in 1930 to 13 million in 1932.People are lining for food and are moving from one place to another as they could not afford rents. Children ages 10-18 are already working in canneries and factories to support their families. Depression is defined as an economic downturn where GDP declines by more than 10%. Economist would differ in their thoughts on what causes depression. For Marxist economist, depression is caused by the crisis of overproduction brought by anarchic production in pursuit of profit. During the US Great Depression, there was a major glut of goods on the market, with inventories three times their normal size. For Keynesian, it’s a simple case of people does not want to spend and they do not have. The US economy was able to bounce back from depression with then President Roosevelt policy of bank holiday and gave authority to Federal Reserve to provide loans to its non members. The government employed 250,000 for its reforestation program and appropriated $500 million relief. Basically it boosted its aggregate demand. The US Great Recession and Financial Crisis According to US National Bureau of Economic Research (NBER), recession is a period when economic growth slows, businesses stop expanding, employment falls, unemployment rises, and housing prices decline (Amadeo). In 2008-2009, US experienced 4 quarters of economic contraction, the worst recession after the Great Depression. Unemployment is up by 14.9 million and 300,000 homeowners are losing their property every month on foreclosure after the NBER declares that recession is over in June 2009 (Amadeo). According to some economic analyst,the recession was triggered by the subprime mortgage crisis. The commercial banks sold home mortgages to investment banks which pooled together thousands of mortgages as ‘mortgaged based securities’ and sold it to pension funds and foreign investors (Moseley).Commercial banks earned from origination fees, while investment banks earned through “broker’? fee. In their haste to increase profit, commercial banks have lowered their credits standards and no longer cared about the credit worthiness of the borrower. There were less and less documentation required to get housing loans. People were lured to borrow and invest on real estate, as it its value increases by 20% every year. However, in 2006, the price of housing and real estate started to decline. The decline resulted into payment delinquencies and defaults of mortgages. In January 2009 mortgage foreclosure have already reached 3 million. Moreover,an average American owns at least 9 credit cards with a total , of $ 17,000 credits (Gibbs).Household debts rose from 50% in 1980 to 100% in 2006. But since, credit institutions have lured even those people who do not have the full capacity to pay their loans; Borrowers could no longer pay their debts . Foreclosures and defaults meant a huge capital loss cfor lenders. As a consequence, there is less bank lending to investment and business, which creates business contraction and eventually unemployment. Government Policies The Federal Reserve adopted expansionary fiscal policies (lower short term interest rates and increased loans to commercial banks), but it failed as banks does not want to extend more credits in its fear of further losing capital. Moreover, the Federal extended loans to investment banks (Bear Stearns) for the first time and bailed out one of the world largest insurance company (AIG) and 2 giant home mortgage companies (Fannie Mae and Freddie Mac) in an attempt to save US financial system. However, the federal wasn’t able to resolve problem of massive household debt, declining real property prices and rising foreclosure rates (Moseley). The US Congress on the other hand, in 2008 passed an economic stimulus bill of $168 billion which includes tax cuts for businesses and tax rebates for ordinary households The Obama administration wrestled with Congress to pass a larger stimulus package of $850 billion on aggregate demand -government spending on education, unemployment benefits and public infrastructure projects to stimulate spending (Moseley). Roots of Financial Crisis During the boom period, there is growth and competition among capitalist which logically results to concentration of profit and capital to the hands of the few capitalist. There is much surplus capital on the hands of the banks .This profits need to move in order for the economy to flow in a regular manner and for profit maximization. To do away with the impending bust, the banks and credit institutions lured the general public into credits and loans, until markets were saturated. As we can see, economists applied Keynesian theory of providing credits and loans to people to avert the bust part of the economic cycle, however, reality have shown us that it has failed miserably as the US economy until now, is recovering from recession. Recovery Generally, the US economy have employed the policy of boosting its aggregate demand to resuscitate its ailing economy. It must be pointed out as well, that the devastation of world war II in Europe and Asia have greatly helped further the US economy to an upswing. It extended loan and aid to both Europe and Asia, which further boost its spending. Its outsourcing of jobs to third world countries of Asia and Latin America have created a heyday once more to US economy after the Great Depression. IV. Conclusion and Recommendation The US has employed Keynesian theory- boosting its aggregate demand to save its economy from further collapse. However, this kind of solution such as increasing government spending and providing credit and loans to corporations is artificially boosting the economy. The giant corporations have been bailed out by taxpayer’? money, while the value of home real estate has yet to rise up. Though, the NBER have declared that recession is over as profits have been showing up on indexes, unemployment is still rampant on the homefront, the growth is mainly due to the outsourcing of jobs by US capitalist on third world country where labor is much cheaper . The US government could start nationalizing its home mortgage agencies and its banking institutions , rather than bailing it out once more, once the bust is cycle coming up. Through nationalization, it’? motive of earning gigantic profits would be turned into public service. On the other hand, using Marxist point of view, cyclical fluctuations and the nation can be spared of its logical hardships of inflation and unemployment if the roots of cyclical fluctuations –which is the capitalist system itself is completely eradicated so that production and appropriation would be socialized and centralized. Bibliography 1.Dickhut Willi.Crises and Class Struggle.Neuer weg Verlag und Druck GmbH, West Germany.1986 2.Niall Ferguson.The End of Prosperity .Time(pp.16-19) Vol 172,No.14.2008 3. http://useconomy.about.com/od/glossary/g/recession.htm 4.http://economics.about.com/cs/businesscycles/a/depressions.htm 5. http://www.spiegel.de/international/business/0,1518,578944,00.html 6.http://timeline.stlouisfed.org/index.cfm?p=timeline 7. http://economiccrisis.us/2011/05/fed-publish-tighter-bank-rules-plan/ 8. http://economiccrisis.us/2011/05/government-spending-biggest-threat-economic-recovery/ 9.http://www.allabouthistory.org/life-during-the-great-depression.htm Read More