Aftermath of the 2008 Financial Crisis - Report Example

AFETRMATH OF THE 2008 FINANCIAL CRISIS …………………………………… College ………………………………………... …………………………… Introduction The 2008 sub-prime crisis that emerged from the US mortgage market has eventually become a global financial crisis, severely hitting almost all industries worldwide and causing serious economic meltdown including growth of unemployment. As International Labor Organization reported, unemployment has grown from 20 million to 50 million by the end of 2009 due to the crisis (Bresser-Pereira 2010, p. 499). This paper addresses the recovery process of the economic crisis especially in relation to the economic tools of monetary and fiscal policies that have been found to be effectual to reheat the crisis. Aftermath of 2008 financial crisis In a nutshell, the financial crisis has been the reflection of the imbalance between the growth of real markets and financial sectors. Some major US banks made easy availability of housing loans to its customers, which in turn had led to unprecedented debt-levels, as accounted to be three times the GDP in the US and Europe. Many of the banks’ customers defaulted in repayments of these loans and this bubble burst added liquidity and caused bankruptcy and closing down of these banks. The total economic impacts of this crisis has been accounted as one third of the total values of all companies worldwide. More significantly and obviously, millions of employees lost their jobs and many of them were pushed to poverty. When the recent financial turmoil has hit several economies worldwide, it was observed that due to the crisis, assets prices have been inflated, currents accounts reported larger deficits and slowed-down economic growth of most nations. Though these were quite commonly reported and widely discussed impacts of the crisis, changes in equity prices, employment and output were more dangerous impacts being studied and reviewed by some literatures. Reinhart and Rogoff (2009, p. 466) found that financial crisis in rich countries and emerging markets like Brazil, Russia, India and China have caused tremendous changes in economic variables in common. Broadly speaking, there have been major changing-patterns in housing and equity prices, unemployment rate, government revenues and debt. They detailed that major three impacts of the global credit crisis were a) collapse in assets market, b) profound declines in output and increase in unemployment and c) government’s debt explosions. The financial crisis has caused accumulation of stock of wealth with greater risks and losses in stock markets in almost all developed and emerging economies. The losses in stock market have been accounted as between 30 and 70 percent in 2008. The value of fund-assets have been declined by 25 or more percent by 2008 September and 2009 April. A number of companies found that their capitalization as already wiped out and as a result many of such companies became bankrupt. One very significant sign of this crisis has been falling housing prices in all those crisis-hit countries (Germain 2009, p. 672). Another major consequence of the recent financial crisis was decline in real per capita GDP. During the crisis, the decline in real GDP was smaller for advanced nations as compared with those of emerging countries. The financial crisis has been contaminating smooth functioning of the economy as it has generated a decline in the GDP during 2008 and 2009. According to IMF’s findings, the global activity would be contracted by 1.4 percent in 2009. GDP in real terms would be declining by 2.6% in the US, 4.8 % in the Euro-zone, 6.2 % in Germany and 4.2% in Spain (Pike and Tomaney 2010, p. 507). The 2008 financial crisis has increased the rate of unemployment worldwide. As a result, absolute poverty was more likely to rise in many countries. income disparities were found in most regions of the world due to severe financial crisis. It was projected that global unemployment would be increased by 21 to 50 million. In 2008 alone, global unemployment has been increased by 14 million and recent trends were pointing that there can be severe deterioration. In OECD (Organization for Economic Cooperation and Development) countries, over 7 million people lost their jobs between January 2008 and January 2009 (International Labour Office, 2009, p. 9). Recovery of Financial Crisis During the 2008 financial crisis, institutions and economies at large were seeking ways to get the crisis recovered. Though the most acute and severe phase of the crisis has almost passed, for many institutions and businesses, recovery still remains fragile. World bank (2011) reports that the world economy is moving from a crisis-hit landscape to slower but still solid growth in this year. Global GDP which has been expanded by 3.9% in 2009 is expected to slow to 3.3% in 2011. World Bank (2011) found that most of the developed countries have almost weathered the crisis and by the end of 2010 many emerging nations were able to recover from greater risks associated with the crisis. Countries were tending to fare better conditions as and when they were able to manage current account balances and a reasonable record of fiscal prudence. Other findings are that countries tend to fare better when they have a well managed current maintaining reserves has been found to be an extremely important economic tool especially during the crisis conditions (World bank, 2010) Monetary and Fiscal Policies to reheat the crisis Monetary policy is direct government involvement in the market whereby the government or central bank controls the supply and cost of money. Fiscal policy is also a type of government-involvement that directly influences the economy through taxes and fiscal spending. When a government takes monetary policy, it will as a result increase the supply of money leading to inflation. The money supply can be increased to combat unemployment in an economic or financial crisis situation. As and when money supply increases, housing markets will be more likely to spend more or invest more and it thus increases employment and vise versa. Monetary policy makers affect the supply of funds available in the financial markets by manipulating the assets and liabilities held by the central bank and this in turn affects the prices of those funds as well (Cecchetti 2009, p. 52). Monetary policy also can be used for controlling money by reducing money supply by increasing interest rates in order to combat inflation. When it comes to the case of UK, the government has implemented a series of high profile institutional reforms and the government has also adopted fiscal rules by granting operational control of monetary policy to the Bank of England and by creating a single monetary and financial regulator. The introduction of monetary policies thus has been viewed as doubtful by the government’ response to recover the crisis. Is monetary policy effective in financial crisis? Tighter monetary policy leads to higher macroeconomic risks. A tighter monetary policy actually forms to be channels of restraining consumer spending and business investments and it is more likely that the financial crisis would be still very severe resulting in greater uncertainties about asset values. A tighter monetary policy wont make it easier to value securities by either reducing the opaqueness of securities that were hard to value or by making it easier to assess credit risks (Mishkin, 2009, p. 579). Tighter monetary policy also makes an adverse feedback loop in a way that uncertainties about values of assets would be increasing the credit spreads and it would also be causing economic activity to contract further. This contraction in economic activities will as a result create more uncertainty and it makes the crisis more severe and worse (Mishkin, 2009, p. 579). This illustrates how monetary policy can control circumstances during financial crisis. There can be higher interest rates on default free bonds including Treasury securities and reasonable increase in macroeconomic risks causing higher credit spreads if the government did not cut rates. It is presumed that interest rates relevant to household and business spending are actually higher than what can be viewed or observed presently. It is because, aggregate spending would have been lower and the prevailing crisis conditions would have been much ore severe. A tighter monetary policy might have been very costly. Fiscal Policy to reheat the crisis Fiscal policy is government’s use of its budget, including both the revenues and expenditures sides, intentionally to affect the levels of aggregate demands and thus to affect the general economic activity. The fiscal policy that government adjusts spending and reduces taxes yields good rate of capital formation. Higher capital formation can result in overall economic development in housing marketing as well and this is the case with developed nations. The fiscal policy is used as an effective tool to balance the productive and unproductive resources in order to divert un productive resources to more useful forms and areas. Fiscal policy, being used as a technique to protect the economy from inflation can yield growth of the economy as well. Among different fiscal policies, discretionary fiscal policy, according to Keynesian theory, can be used to help stabilize the economy. Discretionary fiscal policy is a deliberately using variations in government expenditures and taxation so as to affect aggregate demand and thus to affect the total performance of the economy in a short run period of time. In short run, fiscal policy thus affects the business cycle of the economy at large by combating inflation or recession (Carbaugh, 2010, p. 301). Conclusion This piece of research paper has highlighted recent economic crisis and analyzed major consequences of the crisis in both developed and emerging countries. The recovery of the crisis and how monetary and fiscal policies have affected the crisis also have been detailed in this paper. References Bresser-Pereira, LC 2010, The global financial crisis and a new capitalism? Journal of Post Keynesian Economics / Summer 2010, Vol. 32, No. 4 499, M. E Sharpe Inc Carbaugh, RJ 2010, Contemporary Economics: An Applications Approach, Sixth edition, M.E Sharpe Cecchetti, SG 2009, Crisis and Responses: The Federal Reserve in the Early Stages of the Financial Crisis, Journal of Economic Perspectives—Volume 23, Number 1—Winter Germain, R 2009, Financial order and world politics: crisis, change and continuity, International Affairs 85: 4 669–687, The Author(s). Journal Compilation Blackwell Publishing Ltd/The Royal Institute of International Affairs International Labour Office, 2009, Tackling the global jobs crisis: recovery through decent work policies : report of the Director-General, International Labour Organization Mishkin, F.S 2009, Is Monetary Policy Effective during Financial Crises? 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