Global Financial Crisis of 2008 - Case Study Example

Name Institution Tutor Course Global Financial Crisis OF 2008 Introduction In 2008, a major financial crisis hit the United States and this led to a recession. A recession can be defined as a decline in business activities that lower the GDP of a country or state. Kevin and Kalivinder (4) define recession a period associated with reduced activity and economic hardship for a substantial number of people. They term this as a period where jobs reduce and employees actually lose their jobs leading to a rise in the employment level. Though the recession started in the United States, it finally spread to other parts of the world including Europe. This affected the global economic crisis and led to the economic challenges being faced today. Causes of the crisis The major cause of the recession was the fact that banks were able to create large sums of money by lending individuals especially those in the real estate business. The prices of houses increased due to the accessibility of funds from the banks (Friedman, 198). When the interest rates accumulated people and organizations were unable to pay back the loans and the banks feared going bankrupt. They therefore reduced their lending leading to a fall in the prices in the market. Due to fear of further losses by people who had borrowed money at higher rates, they sold their property to repay their loans. This led to a fall in the price of house. Another cause of the recession was the fall of the Lehman Brothers in September 2008. Lehman Brothers Holdings was a prominent security firm in the US and its fall caused great fear in the financial markets.(Warwick & Andrew, 5) Banks literally stopped loaning each other and as much as the authorities tried to rescue the economy by injecting money into the financial markets but the damage was done already. Effects of the global financial crisis Increase in unemployment Due to the decrease in demand, many companies were not operational and so most of them closed down. This close-down rendered many employees jobless leading to an increase in the unemployment level. These people initially worked in these firms when the recession occurred. In another case, unemployment may arise when the firms fail to employ people because they are trying to reduce their cooperation costs (Christopher & Steven, 2). To do this, they will deduct salaries of their current employees, fire the current employees and hire others at lower wages or lastly fail to employ more people. The unemployed individuals were denied an opportunity to train themselves and to gain more skills which would afterwards help them secure jobs at organizations after the recession. Fall in tax revenue During the 2008 global financial crisis, many firms were making losses meaning that the government received little or no corporation tax from these firms. A rise in unemployment also lowered the unemployed did not pay taxes and the ones who were employed received little wages and so they paid low income tax. Since the wages were hardly enough, people had to reduce their expenditure and this only meant that the VAT tax also reduced. During a recession people tend to pay less tax (Black, Trudi and Barry 20) Government spending The 2008 recession saw many governments spend a lot of money in an attempt to rescue the economy. Earlier attempts by the government to spend money on the recession had been rejected by the officials who argued that the plan would still fail and the recession would still prevail. They injected cash some of which was borrowed from other states (Claes 15).According to him, governments saw to it that interest rates at the banks was reduced to almost zero to increase the rate of borrowing by organizations or by individuals. Budget deficit Due to the fall in tax revenues, the states suffered a budget deficit and an increase in government borrowing (Slemrod & Jon, 106). The governments were not in a position to raise the amount needed to maintain a balanced budget. Therefore the state had to borrow money in order to maintain the local government and also ensure that they operate at a balanced budget. Challenges facing the international economic thinking after the great recession of 2008 The great recession brought about challenges in the economic world and some of these are still felt up to today. Governments and financial institutions from all over the globe are working on improving these harsh situations. However some of these challenges will take longer to rectify while some may never change at all. According to Black, Trudi and Barry (20), unemployment, tax revenue, government borrowing and the level of output are some of the factors that were affected by the great global recession of the year 2008.Some of these factors have been dealt with already by the local governments. Unemployment was a serious result of this Great Recession. Industries were making losses due to the high production cost and therefore the management had to reduce the wages of employees or fire them to reduce these costs. According to Christopher and Steven (1), after job losses in the early 2008, even more jobs were lost during the latter half of the same year. The employment rate has up to now not gone back to where it was before the recession. Employment statistics show that it will take a while before the employment rises back to normal. This is due to the fact that, during the recession, many people lacked an opportunity to gain more skills and this highly affected their reputation as they were unable to secure jobs even after the recession. Tax revenue was also really affected by the recession. Due to the rise in unemployment, the government received so little income tax. This made it hard for the states to finance various activities including the education sector. The sector alongside health care, are still facing challenges because of this drawback. Chernick et al. (3) confirms that between the fiscal years 2007-2010 the nominal tax revenues reduced by 7.6%. This sharp decrease led to a reduction in the state employment and also help to the local governments who depended on the money collected s tax for local developments. Chernick et al. (4) continues to indicate that the average family income dropped by 17% while the real income dropped by 36%. This led to a decrease in the overall expenditure as the individuals disposable income was reduced. Therefore, tax collected in the form of VAT also dropped. As a measure to return the economy of the globe back to normal, governments borrowed money from investment firms and other states that had not been affected by the recession. This was in a bid to inject more money into the economy and rescue the sectors affected by the recession. This borrowing however has challenged many nations as the loans have not yet been paid in full. This is a great burden on the taxpayers who are forced to pay more tax to pay back this loan. Today’s governments have adopted policies that held reduce government borrowing. In the European Union, states have adopted the single currency as a method of control. States that join the EU are expected to control their borrowing via the “Stability Pact” which actually specifies the amount of money a state can borrow (Adams 205). Borrowing by the government is actually good as it helps maintain a balanced budget and cater for the states’ expenses. According to Claes (15) however, continuous borrowing may cause tremendous consequences whereby a country’s national debt increases to a point where it receives pressure from the lenders. The loans also have to be paid back with a very high interest rate. In order to pay this back, the government either raises the income tax or increases public expenditure. Public expenditure helps a great deal to raise money in the form of tax paid on purchased goods. During the great recession, investment in many countries was very low as production was really affected by the recession. Many investors opted to keep their money awaiting better times when full production resumed. This lost output may be limited but if the recession only last for some time. However, if the recession stays longer, like in the case of the period 2007-2009, the lost output may be enormous. The recessions not only reduce the country’s output but also reduce its potential to produce output. (Margaret 125). During the period of recession, a country is expected to be producing at its full potential, involving full labour but this is not always possible with low investments, low labour and inadequate resources. Conclusion The US recession of 2008, which also affected other regions including Europe and Asia, had very negative effects on the US economy and the whole world at large. The rest of the world was affected because before the recession they were trading with the US and any negative effect on the US economy would automatically affect them. Some of the sectors affected by the recession are already performing well but for some like unemployment may take a little longer. Though the employment rate has risen from 2011 to date, still the number is lower than before the recession. Works Cited Adams, Steve. Fundamentals of Business Economics. Oxford: Elsevier. 2009. Internet resource. Black, P A, Trudi Hartzenberg, and Barry Standish. Economics: Principles and Practice. Cape Town: Pearson Education South Africa in association with the IMM, 2000. Print. Chernick H., Cordelia R., Jennifer T. Tax Structure and Instability: The Great Recession and the States. Web. 2013. http://web.stanford.edu/group/scspi/_media/working_papers/chernick_reimers_tennant_tax-struct-revenue.pdf Christopher J. G., Steven M. M. Employment loss and the 2007-2009 recession. Web. 2011. http://www.bls.gov/opub/mlr/2011/04/art1full.pdf Claes, Norgren. The Causes of the Global Financial Crisis and Their Implications for Supreme Audit Institutions. Stockholm. Web. 2010. http://www.intosai.org/uploads/gaohq4709242v1finalsubgroup1paper.pdf Friedman, Jeff. What Caused the Financial Crisis. Philadelphia: University of Pennsylvania Press, 2011. Internet resource. Kevin L. and Kalivinder S. Decision-Making in Hard Times: What is a Recession, Why Do We Care and How Do We Know When We Are in One? Web. 2009. http://www.nottinghamenterprise.com/cfcm/documents/papers/10-08.pdf Slemrod, Joel, and Jon M. Bakija. Taxing Ourselves: A Citizen's Guide to the Debate Over Taxes. Cambridge, Mass: MIT Press, 2004. Print. Warwick J. M., Andrew S. Global and financial crisis: causes and consequences. Web. 2009 http://melbourneinstitute.com/downloads/conferences/mckibbin_stoeckel_session_5.pdf Read More