Monetary Policy and the Housing Bubble - Essay Example

Betty Moon, Wei Hsuan Chien, Wai Sum Vincent Cheung ECONS 302 28th, Nov. Project Report 2 & 3 There were several recessions that have happened in U.S history and there are many reasons behind the recessions. The National Bureau of Economic Research does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. The recession officially ended in June 2009, according to the Business Cycle Dating Committee of the National Bureau of Economic Research, the official arbiter of such dates. It began in December 2007 and lasted 18 months which was the longest recession since World War 2. By observing the U.S Gross Domestic Production (GDP) and the employment data, we can conclude that the current state of the U.S economy is recovering from the recession. The GDP is an important variable because GDP represents the total dollar value of all goods and services which being produced in the period time. The GDP is also related to the real income, employment and industry production. These reasons are why GDP is an important indicator to a country’s economy state. By looking at the Quarter-to-Quarter growth in real GDP graph (Bureau of Economic Analysis) the GDP in the last two quarters of 2008 and the first two quarters of 2009 are negative. Especially the last quarter in 2008, the GDP is down by 9% which means the economy of U.S had dropped 9% in the over the last quarter of 2008. However, from the third quarter of 2009 the GDP had grown back to positive and it stayed positive from 2010 to 2012. By using the previous data we can conclude that the recession is over and the U.S economy is recovering now. The other important variable is the employment data. During the recession, the companies need to decrease the expenditure in order to keep the company running and one of the ways to decrease expenditure is firing some employees or hiring less workers. Therefore, the employment rate would drop during the recession. In Full-Time Equivalent Employees by Industry (Bureau of Economic Analysis), we can easily tell the number of employees dropped from 127,383,000 to 121,078,000 during 2008 to 2009 which means there are about 6,000,000 people lost their job during 2008 to 2009. In 2011, the number of equivalent of employees bounced back to 121,757,000 which is a good sign for U.S economy. There are many factors which can cause the economic recession. The most common reason is the declining in GDP growth and it brings the high unemployment rate, inflation and other economic problems. The latest recession in 2008 is because of the bubble burst in housing price. In 2006 the housing price in U.S peaked too high and the price started falling since 2007. The homeowners and the people who invested in real estate were facing a huge loss. Comparing the current GDP to the GDP before recession, we can realize that the GDP before recession is slightly lower than the current GDP. Therefore, U.S economy is recovered from the recession which was started from 2008. However, by observing the gross domestic investment data (Bureau of Economic Analysis table 5.2.3), the gross domestic investment in 2011 is still lower than 2004 to 2008. We can assume that the U.S economy is not fully recovered because people cannot have that much money to invest comparing to the time before the recession. We compared the recession between 2001 and 2008. These two recessions are interesting because they are really close to us, and most of us should remember how it was, and what was happening at that time. There were few main reasons that why the U.S. economy was slipping into recession in 2001. One of the most memorable reasons was the terrorist attack; the terrorist attack bringing down a $10.2 trillion dollar economy is dramatic. Another main cause of 2001 recession was the crash of the dot-com bubble. These two recessions are related because they have some common cause. The main factor that cause the 2008 recession was the housing market problem. There was bubble in it, bank in the housing market led so many people to buy houses, which they couldn't afford, and the bank and everyone are doing that because everyone thought the price of houses could only go up. Making a bubble needs time, government should know that the bank were doing that long time ago, but the government didn’t do anything to control this kind of activities, therefore, the bubble become bigger and bigger, and finally the bubble break, and everyone need to pay for it. We compared these two recessions because we want to tell the president that the history told us escaping is not the real solution for the U.S. economy problem. There are so many real problems that the government knew it but they didn’t fix it. United States need some dramatic new direction; keep-printing money is definitely not a brilliant solution at all. We should take direct action to reverse our out-of-control trade deficits, and carefully manage access to our markets. Fixing these problems and learn from the history is the only way to avoid recession come back every several years. As we discussed in project1, the recession which happened in 2008 is because of the bubble burst in housing price. The cause of this recession is basically started from the “subprime mortgage loan”. The subprime mortgage loan is the loan for the people with bad credit but the interest for the loan is higher than the normal loans. In 2005, the housing price kept increasing so more and more people started buying houses for investment. Many buyers were buying the houses by using the subprime mortgage and the mortgage firms willing to land them the loans because if they could not return the money and interest, the firms could still get the houses and sell the houses to make benefit. Moreover, the firms sold the bond to the banks to make profit. However, in 2006 the housing price started to decline. The houses owners who bought the houses by using the subprime mortgage realized they would lose money by selling the houses and they cannot afford the mortgage and interest so they foreclosed. The mortgage firms cannot sell the houses to make profits and they realized they are facing huge losses. As the result, the subprime mortgage industry collapsed and even the firms tried to sale the houses they cannot sale them with a short time. The bonds that the mortgage firms sold to the banks became worthless at that time. The invested banks thought buying the bonds is a bad investment and the banks started to sell the bonds but this action brings a terrible consequence. The bonds were bought by the organizations as retirement funds or insurance funds. According to the models we learned in the class we can say the demand for funds decreased because the investment dramatically decreased, as the result, the saving decreased as well according to the demand and supply theory. The Fed conducts monetary policy by affecting monetary base through open market operations, discount rate and term auction facility and reserve-deposit ratio through reserve requirements and interest on reserves.The Fed used open market operation monetary policy which is Fed’s preferred method since 1920s. The Fed could buy government bonds paying with new dollars to increase the base. Typically the Fed used to buy short-term T-bills, but Fed bought long-term government bonds and mortgage-backed securities recently. Usually open market operation is used to control the short-term interest rate and the supply of base money. It has a long-term effect on the supply-demand conditions in the securities market. It is easy to see the monetary policy was successful because US recovered from recessioneventually, but it was not the main action to recover from recession and we can say the monetary policy was not really successful. The Fed started to raise rates in mid 2004 until mid 2006. The bubble emerged during this period when rates were going up. However, US monetary policy falls apart when compared with Canada monetary policy.As seen in the graph below, almost every rateis close between US and Canada. However US had a housing bubble, but not Canada. This means monetary policy may not be the main reason that cause housing bubble and recover from it. The graph above tells us the relationship between the home-purchase loans and the time. The most important actions taken by the Obama Administration is the housing policy. It is because living is the basic needs for all of the people in United States. Even homeless people, they are looking for a shell to stay everyday. Therefore, you can tell how important the housing policy is. The Federal Housing Administration had insured $1.44 billion worth of home loans through the stimulus for 6,327 borrowers who collectively owed $77.6 million in federal tax debts. I think this is a good and clever action, I believe that the policy should be working well in the future but obviously not now. It is because the Federal Housing Administration did not have adequate controls in place to enforce those prohibitions in its disbursement of stimulus-backed mortgage insurance. This is really dangerous for the housing market of United States, because we don’t have a good management department in the States. No matter how excellent the policy are, if we don’t have a good management department to apply and manage those policies, we are just wasting time and money on it. Therefore, I think the solution of the current housing situation is to create a new department to manage all of the policy thatpublish by the Federal Housing Administration properly. Government deficit and trade deficit is yet another aspect that has characterized the Obama administration. The state of government deficit and trade deficit has been an issue of concern for a long period now. This is because, there has been more importation into the USA than the export, escalating the trade deficit and increasing the debt that the government owes. However, the situation seems to be changing, with the current data indicating an improvement in the trade system. The National deficit of the USA decreased from $43.8 billion in August to $41.5 billion in September 2012 (USCB, n.p.). This was as a result of the increase in the quantity of exports for this period. The quantity of international goods and services increased with a high margin during this period, even though the import of goods also increased. The deficit was reduced by the fact that the increase in exports had a higher margin than the increase in imports. Geographically, the goods deficit with China increased from $28.7 billion in August to $29.1 billion during this period, while the deficit with the European countries decreased from $11.7 billion in August to $8.6 billion (USCB, n.p.). This is a clear indication that the manufacturing capacity of the USA has not improved sufficiently, since most of the goods imported from China are the manufactured commodities. Therefore, this issue raises concern, since it indicates that the situation of the US manufacturing industry is still wanting. The government deficit is another issue raising concern, since the government sold $654 billion worth of securities to foreign citizens and governments in 2010 to fund its operations, increasing the government deficit substantially (USCB, n.p.). The concerns raised by this trend points to the need for government facilitation of the manufacturing sector, to revive it and boost its performance. This will ensure that the country exports more manufactured commodities than it imports, an aspect that will help to reduce the government deficit as well as the trade deficit (Richman, Howard and Jesse, 43). However, it is important to point out that the government has been putting appropriate measures to mitigate the situation, something that has seen an improvement in the deficit situation. The US companies earned more from their foreign sales during the period, while the businesses and consumers spent much less in international purchases. This is a positive trend that can help in addressing the deficit challenges. However, the most pressing issues in the U.S. economy today is unemployment. Unemployment has stood out as the most disturbing issue in the American economy today. The data indicates a consistent increase in concerns over the unemployment situation in the USA. In June 2012, 25% of the Americans were concerned over the unemployment situation as the most pressing economic concept (Kropf and Hudson, 44). This percentage increased to 28% in July and a high of 32% in September. The data for the employment concern ranked higher than the data for the overall economic concern. The rate of unemployment in the USA increased in October of this year, reaching 7.9, despite the fact that it had decreased in September (Kropf and Hudson, 47). Thus, the number of the unemployed Americans stood at 12.3 million by the close of September, a figure that raises a great concern. Several reasons have contributed to the increased unemployment situation. Globalization and the resultant trade competition has seen most of the companies in the USA either layoff some workers or unable to expand their job bases, since other companies from all over the world are competing with them for the same markets (Kropf and Hudson, 51). Additionally, considering that the wage rate for most countries, especially the Southern Asian countries, are lower compared to the USA wage rates, most companies have resulted to outsourcing and off-shoring to reduce the operational expenses. This has seen some jobs taken up by foreigners, which would have otherwise been taken up by the US citizens (Kropf and Hudson, 45). Therefore, some recommendations for addressing the unemployment challenge include back-sourcing, which entails reverting back the outsourced jobs from foreign countries back to the USA. However, this will affected the companies involved, since it will increase their expenses, thus lowering their profitability even further. This is detrimental to the US economy, since such companies will not be able to pay substantial taxes, reducing the rate of economic growth (Kropf and Hudson, 50). Therefore, government support and facilitation of the manufacturing sector is a plausible option, since this will promote the rise of the manufacturing activities and increased involvement in the industrial sector, which will create job opportunities (Kropf and Hudson, 49). Government facilitation of the manufacturing sector is essential, since it gives double benefits. It will promote the reduction of unemployment, while at the same time increasing the exports for manufactured goods and reducing the imports. This will improve the country’s trade deficit situation. Works Cited Kropf, Jurgen, and Hudson Nicole. Current Employment Statistics seasonal adjustment and the 2007–2009 recession. Monthly Labor Review, 44 (2012): 42-53. Print. United States Census Bureau (USCB). U.S. International Trade in Goods and Services Highlights: Goods and Services Deficit Decreases in September 2012. http://www.census.gov/indicator/www/ustrade.html "Housing: U.S. Home Price Index." Project America, 6 2009. Web. Web. 15 Oct. 2012. . Griffith, John. "The Federal Housing Administration Saved the Housing Market." 10/13/2012, . Gross Domestic Product (GDP) Graph . 2012. Bureau of Economic Analysis table 5.2.3. Photograph. Bureau of Economic Analysis Web. August 29th.  Levitin, Adam. "Monetary Policy and the Housing Bubble." 10/13/2012 . Photograph. Bureau of Economic Analysis Web. August 29th.  Real Gross Domestic Product 2012. Photograph. Bureau of Economic Analysis Web. August 29th.  Richman, Raymond L, Howard B. Richman, and Jesse T. Richman. Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before It's Too Late. Pittsburgh, Penn: Ideal Taxes Association, 2008. Print. "The National Bureau of Economic Research." US Business Cycle Expansions and Contractions. N.p., 20 Sep 2010. Web. 9 Sep 2012. . Read More