Economic Recession and Government Policy Tools - Literature review Example

ECONOMIC RECESSION AND GOVERNMENT POLICY TOOLS Economic Recession and Government Policy Tools Introduction Considering the recent financial crisis that hit the global economy recently, questions arose especially developed countries. Rates of unemployment were rising, the housing sector fell, company profits dwindled, and financial markets tumbled. The single word that can describe these issues is the recession. The economic crisis made many countries witness recessions as in the case of other historical events. In the past four decades, simultaneous recessions have prevailed in developed economies many times, including 1970s, 1980s, 1990s, and 2000s (FRBSF 2010). Since the U.S. serves as the biggest economy worldwide based on the strong financial and trade relationships it has with other countries, most of these synchronized recessions have coincided with those of the U.S. Even though the recessions witnessed in the U.S. have reduced over time, the recent global economic crisis revered the trend. The recent crisis was one of the deepest and longest after the Great Depression, which was witnessed in the 1930s. The recession resulted in a major rise in levels of unemployment in line with notable declines in investment, consumption, and output (Claessens and Kose 2015). Although no official definition is accorded to a recession, the generally accepted term is decreased economic activity over time. Short durations of decline in economic activity are not described as recessions. Many analysts, commentators, and economists consider a crisis a recession when the real GDP (Gross Domestic Product) of a country declines for two successive quarters, meaning that a country’s economy is contracting (FRBSF 2010). GDP describes all the values of goods and services produced in a given country. Although this is the generally accepted term, it is affiliated with various drawbacks. For instance, laying emphasis on GDP alone is a narrow interpretation. This creates a need to incorporate a broad range of economic activity measures to facilitate in determining whether a nation is in fact experiencing a recession. The use of these indicators also facilitate in offering a timelier that helps gauge an economy’s state (White House 2010). This paper discusses the economic recession based on the diverse tools that the government adopts to facilitate in avoiding or limiting the negative effects affiliated with a recession. Calculating Recession in an Economy Although many countries have gone out of the recession for at least two years, most individuals in these countries still feel as they are yet stuck. The rates of unemployment are still high, consumers still have debts for their houses, and foreclosure activities are still being witnessed. However, with regard to determining whether a nation is in a recession, most of the factors do not have notable impact as in the case of the GDP (Bailey and Chapain 2012, p. 67). However, other factors that come into play when measuring a recession include employment levels, real income, retail and wholesale sales, industrial production. These factors play a crucial role with respect to making more timely and ample decision. In case economists assign significant weight on GDP as a key factor influencing a recession, they experience threats when treating an economy as one thing whereas the prevailing state of affairs appears different. In addition to this, it is evident that viewing inflation through economic growth and contraction as opposed to human forces, the term fails to capture mood an economy associates it with (King and Cushman 2011, p. 84). A recession depicts a shrinking economy where unemployment rises and output declines stipulating that a country is out of recession tends to miss the point at times. This indicates that a country is witnessing growth again. This should then set a pace for certain forms of fiscal situations, which lead to improvement of average consumers’ lives. Nevertheless, there may be years when households continue to witness financial sufferings. Thus, it is ideal to introduce measures that help reveal the “bad times” a country is going through. In the perspective of many economists, various measures can be used to determine if a country is undergoing a recession and the ways in which it can be made to recover (Jackson 2011, p. 109). The level of unemployment is one of the key factors used to determine whether a country is in a recession. The difference between a number of unemployed individuals before a recession and those unemployed after the recession play a key role in determining the impact of inflation. Since the recession started, many people still have no work and have not managed to attain any. This is one of the key reasons as to why a large number of people are still feeling as if they are in a recession. Presently, the rate of unemployment in the U.S. economy lies at 9.1 percent compared to 5 percent before the end of 2007, when the recession started officially (Cynamon, et al. 2012, p. 72). These figures reveal that notable growth is needed to help offset the labour market before individuals can argue that the turbulent economic times have ended. Furthermore, further measures are being adopted by evaluating the data availed by the Bureau of Labour Statistics regarding the ratio of employment to population. Data reveals that approximately 3 percent less of individuals were accorded employment before the start of the recession. The peak employment at the start of 200s was about 6 percent. This reveals that there is a lot of work to be done to cover the 5 percent and 9 percent unemployment rate (White House, 2010). The levels of income are the other key considerations that demand consideration when determining recession within a country. For instance, one of the key challenges with regard to measuring an economy’s growth is evaluating the rate at which it grows, although this does not reveal the segments of the population that are realizing growth from the growth portrayed. It also fails to indicate the ones that have been left behind (Lynn 2010, p. 16). For instance, U.S. data reveals that the economy grew at the start of the 2000s, although the higher income earners are the ones that realized most of the benefits from the growth and not the entire country. Hence, to give a clearer picture regarding the state of the economy at the time, suggestions have been made to measure the health of the financial environment by considering the median wages or through breaking the level of GDP per individual. This way, it would be possible to determine the amount of contribution that an average individual makes to the economy and the ways in which it compares to the past year (Cynamon, et al. 2012, p. 34). Here, when evaluating these metrics, it is easy to note why various populations feel disillusioned by the current state of their economy. For instance, according to a report by the Census Bureau of the U.S., the average median income for every household was approximately $49,445 in 2010. This reflected a drop by about 6 percent compared to the year when the recession started. It was also on par with the average earnings Americans witnessed in 1996 when inflation is put into consideration. Furthermore, in the case of real GDP per capita, it accounted to $46,884 in 2010, which was less than $500 compared to 2005 (Claessens and Kose 2015). Although the economy may be witnessing growth, many individuals income still reflects the one realized in the past. In this perspective, therefore, it is true that the levels of income play a crucial role with regard to determining the impact of a recession on an economy (Jackson 2011, p. 89). The gap witnessed in the level of GDP helps determine the influence of inflation. As opposed to laying emphasis on the absolute number of GDP, which is reported every quarter of a year, it is crucial to focus on the GDP gap, which is a bit more complex process, although it offers more understandable statistics. The data obtained in this case is gathered from Congressional Budget Office, which embarks on the calculation of the level of production of an economy, especially if it is operating at full employment as well as full output. It also compares the information gathered in this case with an actual output of the economy (White House 2010). The difference that results is the output gap or GDP gap, which shows the deficiency of an economy. Presently, however, the gap that prevails between a country’s production level and what it produce, especially in the case of the U.S. economy is around 6 percent, which represents approximately $1 trillion. In this case, it is not possible for an economy to recover form a recession until the prevailing gap is closed (FRBSF, 2010). Government Avoidance of Recession’s Negative Impacts Between 2007 and 2008, United States experienced one of the worst recessions since the 1930s. After the country felt the effect, other nations globally started reflecting declining employment and output. Any hopes that other countries around the world were in a position to aid the U.S. from the recession were fruitless. The country was encountering a decline in growth, where individuals lost more than 3 million jobs at the time. The major cause of the crisis was the housing bubble as well as the prevailing financial crisis (Lynn 2010, p. 16). For a period of several months, households lost trillions of dollars’ worth of wealth, leading to a massive drop in the level of consumer spending. Based on the situation prevalent in the U.S. during the recession, the government managed to impose measures for regulating inflation although major challenges, although major challenges still prevail. For instance, with the rate of unemployment being more than 9.7 percent, it is true that although the economy is showing signs of recovery, it is yet to recover, creating a need for the government to impose measures that will drive the country out of the recession entirely (Gould 2013, p. 104). To aid in the recovery of the U.S. economy, the government is increasing spending with the goal of boosting consumer demand. The state, as well as local governments, felt the huge impact of the recession forcing them to cut back on vital services and started retrenching. The government has ejected approximately $300 billion to both local and state governments to address their budgeting needs in the coming two fiscal years. In case these drawbacks are eliminated by increases in tax, the negative impact witnessed on consumer spending will be significant. Furthermore, if at all laying of first responders and teachers is closed, the impact towards public safety and education would be terrifying (Gould 2013, p. 69). Presently, the high rate of unemployment results from the fall in demand. The rate of unemployment is not currently high due to the influence of structural changes as well as because of the reluctance of workers to seek jobs. The rate is high because the economy is not producing enough to reach normal levels. In this case, it is the government’s role as well as policy makers to facilitate in generating private growth and demand (White House 2010). Although employment and output are growing, it is appropriate to encourage robust growth, which will accelerate employment and output returns to reach normal levels. One of the key strategies influencing this issue is the lending funds, which will facilitate in helping small firms acquire credit for growth. The other strategy that is essential is ensuring that taxes on capital gains are eliminated, especially in the case of those individuals investing in small businesses (Bailey and Chapain 2012, p. 112). The government is embarking on efforts aimed at jumpstarting clean energy transformation. According to the Recovery act, the tax credit on manufacturing clean energy has played a vital role in allowing firms in the U.S. to emerge as providers of clean energy products, including solar panels and turbines. This program has encouraged many investors, providing an avenue for the creation of additional jobs that will allow the economy to operate in a healthy manner over the long run (Gould 2013, p. 89). To further aid the local and state governments in coping with the effects of the recession, more aid is being allocated to them. On the road to recovery, the local and state governments are the ones that are dragging the economy behind. It is challenging for them to gather sufficient funds to sustain vital services as well as teachers. This is one of the key areas the government can focus on to offer support to communities, families, as well as local firms. These actions have been targeted appropriately. The government is aware of the long-run financial challenges creating a need to sustain order in the financial sector. It is showing strong commitments with regard to coping with budget deficits with the recovery of the economy (Lynn 2010, 113). Nevertheless, it would not be ideal for the government to tighten fiscal policy instantly to address the long-run problem. This strategy would also not be ideal with in terms of foregoing extra spending on emergency to minimize unemployment. This is because instant contraction of finances would lead to a severe recession before the process of recovering has completed, leading to permanent higher unemployment. The responsible actions that the government should embark on include helping private sectors to recover strongly by implementing appropriate policies for individuals as well as the long-term growth of the economy (King and Cushman 2011, p. 15). Financial regulatory reform is another key area that the government can focus on to avoid the negative impacts of the recession. To cope with the jobs problems, it would be ideal to ensure that adequate regulatory frameworks have been put in place to avoid catastrophic failures, such as the ones witnessed during the Great Depression. Failure by the government to update the regulatory system to facilitate in responding to innovation in the financial sector may result in the disastrous meltdown of the financial system. Therefore, setting ideal rules would facilitate in preventing a crisis (FRBSF 2010). Thorough regulation as a provision of ideal capital needs is a key feature in the legislation process. For instance, the economic recession has revealed that the failure of financial institutions may pose threats to an entire system, particularly if this falls within regulatory cracks. Here, the government has set up measures to ensure that institutions whose failure may cause threats to the entire financial system be governed by the Fed (Federal Reserve). This is irrespective of whether an institution is a hedge fund, a bank, or an insurance company. As such, a single controller will be accountable for monitoring the institutions (Cynamon, et al. 2012, p. 57). The monitoring process is also being improved. Here, major regulators are supposed to ensure that they evaluate both the soundness and safety of certain institutions to enhance the entire system’s stability. Furthermore, a number of regulators have been set in a place whose role will be to evaluate the developing risks while the regulatory agencies will be responsible for adjusting standards to facilitate in safeguarding the system. In this case, the ideal way through which regulators can make sure that they avoid failure of financial institutions is by refraining from assuming that it is the duty of the government to save them in the event of challenges (Claessens and Kose 2015). The government has set in place these measures to ensure that capital needs serve as a regulation tool. With sufficient capital, institutions manage to come out of devastating financial situations. This way, since the money of an organization, is the primary concern, they will be encouraged to refrain from taking an unreasonable risk. Furthermore, when sufficient capital requirements are set, especially for those institutions that are interconnected, it will be possible to enhance the stability of the financial system (FRBSF, 2010). Some institutions engage in financial irregularities because they are confident that they will be bailed out when they fall. However, in an aim to safeguard the interest of the tax payers, it is ideal for the government to assure that they will not be bailed out in the event of such activities. For instance, the crisis revealed that in case a financial institution defaults, policy makers tend to result in bad options, such as letting the organization to go to conventional bankruptcy (Bailey and Chapain 9 2012). These actions may cause other institutions to fail, causing severe damage to the entire economy. Policymakers may also opt to bail out the institutions. However, this has the influence of putting the taxpayer’s money at risk. Here, it is vital for the government to establish a third option, which would facilitate the establishment of s sensible option that would deal with the needs of the troubled institution, such as sale of its assets. This would provide an avenue for dealing with the institutions problems and avoid panic in the entire system (Jackson, 2011, p. 16). Conclusion A recession has devastating effects on an economy. The rates of unemployment rise, prices go up, consumer spending drops while the government encounters challenges when trying to meet the needs of the population adequately. In this case, it is the role of the government, policy makers, and commentators to ensure that they implement appropriate policies and impose legislations that will foster growth and improve the health of an economy. This, way, an economy finds it easy to cope with future challenges that may result from a recession. 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White House 2010, Treatment and Prevention: Ending the Great Recession and Ensuring that It Doesn’t Happen Again, viewed 3 July 2015, . Read More