Monetary and Fiscal Policy in the US - Essay Example

? Economics In most cases, economists, financial experts, and government policy makers are able to plan for economic prospect. Significantly, the financial crisis that occurred in 2008 got them not prepared because the economy in previous years preceding the financial crisis was strong. As a result, the financial crisis that occurred was much of a surprise to the policy makers as they had to finds ways to intervene in the economy. Considerably, it is essential to understand what the effects of monetary and fiscal policies were before and after the financial crisis in United States of America economy. Although, Federal Reserve uses monetary policies tools such as open market operations, the discount rate and reserve requirement, the tools affect the economy either positively or negatively (Giuseppe, 2009). More so, increase or decrease of the reserve requirement affects interest rates in a short period as financial institutions lack funds to issue to investors. Nonetheless, higher discount rates make borrowing less attractive from Federal Reserve for many banks while low discount rate make borrowing more attractive for banks because they have access to more deposits. More so, it is necessary to establish how monetary policy caused the financial crisis in the country Considerably, Federal Reserve plays a crucial role in determining money supply in the economy that eventually affect credit availability and the interest rates in the United States. More significantly, Federal Reserve lowered interest rates in 2001 as it induced investors to borrow money to finance mortgages and purchase of houses for speculation. However, in 2004 Federal Reserve increased the interest rates making payments of mortgages difficult thus, leading to increase in house prices. More so, businesses and individuals had accumulated a lot of interest from the mortgages, making it difficult to pay leading to high defaulting rate of the borrowed funds. More than that, the boom in house markets impacted on financial market lead to high levels of delinquencies and foreclosures. Considerably, the recession period was marked by high levels of economic downturn as the decline in the gross domestic product increased with high levels of unemployment during the recession period (Giuseppe, 2009). In addition, there is a lower level of money in the economy with a high level of bankruptcies and default in loan repayment crisis as real income declines with the economic downturn becomes worse impeding the Federal Reserve to take action as the economic recession period showed likelihood of economic depression era occurrence. In addition, the Federal reserve set reserve requirements limits for banks and financial institutions as it decreased reserve requirements between 2001-2005 by about 20% funds reserves owned by banks were used to give out more loans to businesses and individuals. As a result, there was an increase in money supply available in the economy thus, leading to inflation. However, in 2005 to 2008 Federal Reserve revised its monetary policy reducing the growth of GDP as it enhanced reduction of money supply in the economy. Nonetheless, the development of collateral mortgage obligations structured product served as a security for borrowing of money thus, individuals later had easer availability to loans .as they used insurance as security for the provision of safety for the loan borrowed if defaulted (Blanchard, 2008). Nonetheless, Federal Reserve failed to recognize liquidity problem in 2007, as it increased the interbank rates while failing to provide an immediate solution to the increasing money supply. As a result, interest rate rose to unprecedented levels that eventually led the economy into a period of recession. With the worsening of the economy, the Federal Reserve provided solutions meant to solve challenges that the USA economy was facing in the year 2008 as it uses monetary policies to solve the financial crisis. Federal Reserve increased money supply in the economy by forming Term Auction Facility (TAF) in December 2007. The main aim of the facility was to avoid banks going to the discount window as they could borrow directly from the Federal Reserve.In order to reduce, the interest rate it facilitated orderly short term credit market that increased credit availability (Giuseppe, 2009). More significantly, the Fed Reserve provided long-term solutions while failing to provide solutions that could reinstate the economic in the short run. More so, as a way of increasing liquidity in the economy the Fed Reserve drained bank reserve from its own system as it lowered the interest rates and reserve requirement limit. As a result, tightening monetary policy was a failure because, it precipitated the financial crisis instead of reducing its effect on the economy of the country. More than often, government increases its spending to boost Gross Domestic Product (GDP) growth that results in reduction in the unemployment rate levels to the required low level. Nonetheless, in the past years the United States of America budgets was in deficit before the year 2008 due to war, economic expansion, and financial crisis. As a result, national debt of the country increased rapidly over the years (Mankiw, 2012). The fiscal policies used by the government comprised of government spending and tax rules that it could influence its change according to the situation. Considerably, it is imperative that fiscal policies focus on development of a country’s economy. In most cases, the government engages in the provision of the environment of increased production of goods and services that increase income levels. As a result, they spend their income on consumption of food, health, household rent. Considerably, the government gives individuals stimulus through capital goods such as roads and buildings. Increased government spending and high tax rates led to high levels of consumption rather than investment that could have generated revenue and budget deficit. In addition, government foreign spending increased due to the war on terror that entails the government to send it soldiers to Afghanistan in 2001 and Iraq in 2003 thus straining the economy (Mishkin, 2008). More significantly, foreign policy of the country increased government spending, which made the country’s budget be in deficit. These made the country divert some of its revenues to the war causing strain on the economy in budget deficits and financial crisis in the country. Nonetheless, during the recession period use of contractionary fiscal policies is set to control the rising in inflation and unemployment rate. This includes the increase of taxes, decrease of government spending and decreased transfer payments that reduce the inflationary pressures on a country’s economy. Changes in government spending and taxation were aimed at controlling the economic crisis in 2008, after the financial crisis in the country’s economy (Mishkin, 2008). More significantly, it was necessary for the government to put mechanisms in the economy to restore it from recession. More significantly, government brought the economic stimulus package and bailout in order to rescue the economy from recession. As a result, it invested trillions of dollars to promote economic stability and ultimate growth through investment in government service and infrastructure from the economic stimulus package. In addition, government provided Trouble Asset Relief Program (TARP) given to Wall Street Investments banks such as Goldman Sachs and other investment and saving banks like Bank of America to stabilize the economy. This was carried out through acquisition of mortgage securities and concerned asset from the institution that were on the verge of collapsing, as the banks were losing their depositors at a higher rate, and did not have liquid asset for carrying out its daily transactions. The government also put in place the fiscal policies where more of benefits to the economy were derived in the long run rather than short run by countering the economic crisis that had affected the economy (Mishkin, 2008). However, the economic stimulus package was direct as it benefited Americans it as they got to meet their consumption and liquidity needs as it increased utilization of resources in investment which made the economy grow. The fiscal policies encouraged demand, where the economy worked below potential in the short run while improving the saving and standards of living within the economy. As a result, the stimulus package stabilized the economy in the long run. The government failed in implementing its policies both before and after the 2008 financial crisis the monetary policies and fiscal policies that were meant to stop the recession did not work out. Moreover, the policy Treasury took in order to save other companies property at cost of others was much of a failure. This is because, the policy destabilized financial markets causing uncertain property price. The proposal put by the government made the stock value deteriorate at a worse rate (Mishkin, 2008). On the other hand, Federal Reserve should have reversed its restrictive monetary policy. This would increase banks reserves as expansive policy could result in increasing liquidity that required by individuals and business. Under the expansionary mode, the influence of expansionary monetary policy causes a reduction in interest rates leading to increased higher levels of capital investment with government injection of funds through selling of open market bonds (Mankiw, 2012). In addition, the Federal Reserve should have provided financial policies that will guide the banks and financial institution when lending. By putting laws that would guide the institutions when borrowing as it should be stringent so as to give loans to people who are able to pay. However, recession is an opportunity that the country should use rebuild the economy by either lowering taxes or government spending by reducing its intervention that will make the economy come out much stronger(Mankiw, 2012). These will encourage investments and create more opportunities for employment resulting to reduced unemployment levels. Moreover, the economy failure was triggered by complexity of the banking system of the United States of America with valuation and liquidity troubles. As a result, it is crucial for the Federal Reserve to monitor the situation and be able to foresee what is going to happen in the future when monitoring banks. Indeed. the government failed as it did not look out earlier at the threats of deeper financial crisis during the recession period as it implemented lower levels of contractionary fiscal policies as it still has government spending in war activities it had earlier began. More significantly, the policies would have been set earlier by the policy makers to control the rise in inflation and unemployment rate. This includes the increase of taxes, decrease of government spending and decreased transfer payments that reduce the inflationary pressures on a country’s economy. On the other hand, the Federal Reserve acted late, as the damage on the financial institutions was already significant in the economy. .References Blanchard, J. (2008). The State of Macro.” Working Paper No. 14259. Cambridge, MA: National Bureau of Economic Research. Giuseppe F. (2009) Whither New Consensus Macroeconomics? Gourinchas Pierre- Olivier 2010 U.S. Monetary Policy, ‘Imbalances’ and the Financial Crisis Mankiw, N. (2012). Principles of Macroeconomics. Mason, OH: South-Western Cengage Learning. Mishkin, F. (2008), Challenges for Inflation Targeting in Emerging Market Countries, Emerging Markets Finance and Trade, 44 (6): 5–16. Read More