The world financial crisis and recession aftermath - Assignment Example

The world financial crisis and recession aftermath The world financial crisis and recession have had such an enormous impact in the global financial system. The onset of the financial crisis was precipitated by the eruption of the subprime mortgage crisis. Due the financial crisis, the world economy include the United States went into deep recession that can be comparable into the Great Recession of the 1930s. According to research, in severe financial crises the crucial indicators such as housing prices and unemployment take longer to hit their lowest points. Several economic strategies have been proposed to tackle the financial crisis and resuscitate the global economy. One school of thought proposes that austerity measures should be taken to cut public expenditure in order to bring the global economy back on course. On the other hand, there are those who advocate for stimulus packages to jumpstart the economy through increased spending ability of the people. In evaluating the best course of action for handling the global recession, I would analyze the current situation based on the Keynesian economic theories. In his General Theory, Keynes renders an opposing view to the classical economic model in which the perfectly competitive markets with flexible measures resulted in self correcting and balancing measures. According to the orthodox doctrine, the Loanable Funds Theory played an important role in determining the interest rates. In this respect, consumption, saving and investment were all functions of the rate of interest. Thus, theory proposed that as long as the interest rate was sufficiently flexible savings automatically turned into investments. However, Keynes pointed out that consumption is a function of income. This implies that in as much the interest rates are flexible, the determinant factor for economic activity was the level of disposable income that individuals had. This argument is relevant to the policy debates concerning the most appropriate approach to the solving of the global financial crisis. I think that it is necessary to ensure that the ordinary citizen has disposable income in order to spur economic recovery. This means that governments should implement stimulus packages in a strategic way to make it possible for money flow in the economy. Use of austerity measures may not have the desired impact on the economies of the world. For instance, I believe that austerity measures may indeed put a cap on the government expenditures and create some control over money interest rates. However, this may only go as far as stagnation of the economy since people will still lack disposable income for consumption. Keynes also rejected the quantity theory of money. Keynes argued that the assumptions upon which the stable velocity held sway were invalid. Also, it should be noted that people hold on to money for a variety of reasons other than transactional purposes. In his money theory, Keynes pointed out that people may hold money as income deposits, business deposits and savings deposits. It is therefore imperative that if the quantity of money changes, then there will be equal changes in the general price level. This implies that the general state of the economy is affected by the amount of money in circulation. For economic growth, there should be sufficient industrial money circulation. Suffice to say, only stimulus packages can pump in money to the economy. On the other hand, austerity measures lead to reduction of the amount of money that is in circulation. The intention of governments worldwide is to move their economies to the path of growth therefore it is imperative that economic policies taken should ensure that there is more money in the economy. The concept of multiplier effect is a major tool that can be used to help governments to maintain high levels of employment even during times of economic depressions. According to Keynesian economics, the multiplier effect can be used by governments to attain a level of national level of income that would prevent unemployment (Arnon 57). Multiplier effect simply means the injection of new demand for goods and services has a trigger effect on the general economy. An improved circular flow of income stimulates further spending patterns and thus creating a positive impact on the general economic conditions. In terms of economic policies, it should be noted one of the reasons for the continued economic depression is the lack of disposable income. People lack access to both credit and employments thus creating a gigantic economic crunch. By applying the multiplier effect, the government can spur economic growth by first pumping some money into the economy. One person’s spending is another person’s income and this will eventually lead to the creation of employment opportunities. In fact, targeted government stimulus packages especially to small and medium enterprises have a great potential of jumpstarting economic growth. Also, the implementation of multiplier effect has enormous impact if it can lead to an increased propensity to consume. The government can cut the rate of direct income tax thus leaving people with extra income to spend. If this extra income can be channeled towards domestic expenditure, it would help to improve the markets for locally produced products and services. This has a circular income effect in that the industries will be able to employ more people hence reducing unemployment levels which has a positive impact on the economy in general. The application of Keynesian stimulus to ease the strain of recession may meet various challenges. One of these challenges is that part of the funds for the stimulus packages are borrowed. The concept of deficit spending is bound for failure since it results in further debt. Essentially, deficit spending means that the government borrows money from banks or other countries and then uses it for stimulus package. In the long run, this borrowed money has to be repaid within a given period and with some interest. This implies that the process of getting the country involves getting the country into debt. The debt burden may have to be passed to the citizens of the country and if there is a delay in getting out of recession, the interest rates for this borrowed money may grow to exponential levels. The other factor that may compromise stimulus packages to ease the strain of recession is the inadequacy and poor focus of the funds. According to the Congressional Budget Office estimates, the United States economy required over 2.9 trillion US Dollars to get out of recession (Leijonhufvud 39). Yet the original government plan had provisions for about eight hundred billion dollars for the stimulus package. This is a clear indication that the funds available for stimulus are not even half of the fraction of the funds needed in actual sense. The insufficient funds mean that some aspects of the economy may not be given consideration. In the end, the focus on economic growth through stimulus may have limited impact due to incomplete implementation of the required projects. The other significant challenge to the implementation of the stimulus package is the issue of focus. It should be noted that the issue of government stimulus packages has been highly politicized over time. Essentially, the projects and sectors that the stimulus packages target have some political bearings. For instance, the government bailout of the automobile industries was marked with immense political interference. Political machinations in the implementation of the stimulus packages imply that professional and economic considerations may be forced to take a backseat. Hence, the intended effect of the stimulus package on the economy may not be fully realized. Also, the extreme positions taken by the politicians from the various parties imply that the eventual implementation of the stimulus package may end up being as a result of mere compromises and political tradeoffs. This poses a challenge since the basis for the stimulus packages should be on economic impact. The stimulus package funds should be put into projects and industries that have the capacity to create the greatest impact on the general economy of the country. Austerity measures refer to government policies that are aimed at cutting public expenditure. This may involve reduction of government expenditure in public services and the amount of benefits that the public receives. According to the proponents of austerity, the government may achieve overall economic expansion by reducing the public’s expectations of government spending and hence encourage private consumption. However, the implementation of austerity measures especially in the midst of recession may be counterproductive to the economy in the long run. This is because reduced government spending may end up curtailing the multiplier effect on the economy. When the government reduces its spending, the rates of unemployment go high and hence leading to general reduction in tax revenue for the government. Also, the expenditure patterns of the people tend to be constrained due to the limited disposable income available as a result of unemployment. Also, austerity measures may lead to a significant reduction in GDP of the country. The amount of money that the people make is significantly reduced when the government reduces its expenditure. The reduction in the GDP of the country results in a lower credit rating. Hence, the country may not be able to raise external funds if need be. This is especially harmful during periods of economic recession since the country may not be in a position to raise external money to fund economic growth. According to Keynesian economics, boom time is the most appropriate period for austerity measures. Keynes argues economic policies that advocate for austerity during recession can only lengthen the recession (Ahiakpor 12). The policies of stimulus packages are having a positive impact on the general economic outlook of the country and the globe albeit slowly. According to the most recent statistics, the unemployment rates in the United States have declined steadily since the beginning of the implementation of the stimulus packages. The economy is also slowly growing although in single digits. It should be noted that deep recessions take considerable time to end and thus the slow progress may not be a negative pointer. On the other hand, austerity measures have had mixed results. For instance in Greece, austerity measures had the initial impact of worsening the financial crisis. Steep cuts in government expenditure led to widespread panic among the citizens who withdrew money from banks and withheld hoping for the worst. However, the strategic implementation of both austerity and stimulus policies is the surest way to get the global economy out of recession. Works Cited Ahiakpor, James. Keynes and the classics reconsidered. New York: Springer Publishers, 1998. Print Arnon, Arie. Perspectives on Keynesian economics New York: Springer Publishers, 2011. Print Leijonhufvud, Axel. On Keynesian economics and the economics of Keynes: A study in monetary theory. Oxford: Oxford University Press, 2007. Print Read More