How Monetary and Fiscal Policies were Implemented during the Recession - Essay Example

?How Monetary and Fiscal Policies Were Implemented During the Recession Recession is a downward economic trend in the business cycle that is characterized by a decline in production and unemployment, whereby the household incomes and spending decline by a great margin. However, not all businesses and households are affected depending on the areas of business where an investor had invested. During recession, most investors become less certain about the future of their businesses and therefore, they delay investing huge sums of money into businesses or other economic projects. Moreover, during the recession, the consumers buy few durable goods, in future expectation of price decline (Bork 3). The year 2008 witnessed the greatest depression since the great depression of the 1930s. This was because of the irrational exuberance in the housing market that led many people to buy houses that they could not afford. These investors were speculative that the future prices of houses would only rise. Previously in 2006, there was a housing bubble whereby the price of housing sector began to decline therefore encouraging many people to buy the houses. The result was that many homeowners took loans to purchase houses. However, in 2008, these homeowners could only sell their houses at a loss than their mortgage prices that they foreclosed (Clarida et al 3). In order to curb this, the government of the United States, and the international monetary fund, took some micro and macroeconomic measures to curb this trend, which led to a great economic down turn. This was achieved by using some monetary and fiscal policies. The monetary process is the process through which the central bank and other money rendering institutions of a country controls the supply of money, the availability of money and the cost of money or the interest rate so that they can achieve a certain common objective. These objectives are done towards the growth and stability of the economy. The monetary policies can be either the contractionary or the expansionary objective. The aim of the expansionary policy increases the total supply of money in the economy, while the contractionary policies decrease the supply of money in the economy. In order to increase the amount of money circulating in the economy, the IMF and the United States government used the expansionary measures (East Tennessee State University web). It is the mandate of the federal reserve of the United States to enact the monetary policies. Board of governors runs the Federal Reserve. The factors, which they considered and applied to curb inflationary tendencies, are the reserve requirements, discount rate, open market operations, and printing money. Most banks in many countries changed the reserve requirements to encourage more banks to start in order to increases the amount of money circulating in the economy. The central banks of these countries have the authority to change the amount that banks should hold in the central bank so that they can be given the right to operate. In the US, the Federal Reserve has the supremacy to set the quantity of the deposits that the associate banks can deposit in order to be given the mandate to operate. To curb the recession, the FED decreased the amount of reserve deposits. The motive was to encourage more investors in the banking industry therefore increasing the amount of money circulating in the economy. This monetary objective achieved its goal since more banks had more money at hand, which increased spending, and possibly inflation (East Tennessee State University web). The other monetary policy used was the discount rate. Discount rate is the discount on the rate of interest rate that the Federal Reserve charges on the banks on the money that they borrow from the Federal Reserve. The central banks decreased or lowered the discount rate during recession. Their objective was to encourage the banks to borrow money from the central banks at a lower rate to increase the amount of money circulating in the economy. This would in turn encourage investments in the country. Source: Watson Wyatt Worldwide. Discount rate according to Citigroup Pension Discount Curve and Liability Index (December 2007-December 2008) Source: US Interest Rate Cuts and Mortgage Bailout Will Avert US Recession in 2008. 11 December 2007. Moreover, the central banks used the open market operations. This is the power of the central banks to buy or sell the securities such as the treasury bills. The open market operations are the most used tool of the monetary policy. Most central banks bought back bonds from the people in order to circulate more money in their economies. This is achieved since the money goes back to the people from the government (East Tennessee State University web). In addition, most governments during the recession used the fiscal policies. The fiscal policies are the methods, which are used by the government to impact and monitor the economy through adjusting taxes and public spending. During recession, some trends could be noticed such as increase in the rate of unemployment, reduced public spending, and reduced inflationary trends. To curb inflation, the FED alongside other central banks of other countries in the world, increased their spending to increase the amount of money circulating in America. For instance, the government of the United States bailed out the General Motors Company alongside Chrysler. These companies became bankrupt, and contributed the highest number of unemployment in US. In Germany, the government increased the spending by bailing out companies such as the Volkswagen while in India, the government bailed out Tata Motors Company (Congdon, and Pepper web) Another fiscal policy used was the taxation policy. The government reduced the taxation policy to increase on the domestic income. The aim was to increase the amount of money per the domestic household in a motive aimed at increasing consumer spending. The move was a success since the increased household spending led to the increase for money circulating in the economy. Consequently, the values of balance of trade became surplus thus increasing the value of the exchange rate of the dollar against other currencies which had depreciated. The above two fiscal policies are known as automatic stabilizers. Source: U.S. Censors Bureau and Bureau of Economic Analysis. Moreover, the government of the United States deliberately manipulated the purchases by increasing the purchase and increasing incentives in a move to increase money circulating among the people in the economy. For instance, the government purchased some of the mortgage policies, which the people were unable to pay. This helped the mortgage companies get back to making profits. This move also helped increase the employment rate that had reduced because of the resection (Bork 3). The diagram below shows the levels of unemployment in USA from 2007 to 2010. Source: Econbrowser: analysis of current economic conditions and policy. May 04, 2012. Works Cited Bork, Lasse “Macro Factors, Monetary Policy Analysis and Affine Term Structures Models” 2010. Web 7 May 2012. < http://lassebork.dk/ThesisLasseBork.pdf> Clarida et al, “The Science of Monetary Policy: A New Keynesian Perspective” 1999, Web 7 May 2012. Congdon, Tim and Pepper, Gordon “How to stop the recession.” 2009. Web 7 May 2012. East Tennessee State University, “Fiscal Policy Vs Monetary Policy.” 2012. Web 7 May 2012. Read More