Global Financial Crisis - Reassessment of Government Intervention in the Economy - Essay Example

Global Financial Crisis: Reassessment of Government Intervention in the Economy. The just ended economic recession is regarded as one of the worst economic crisis to be experienced globally after the Great Depression. The economic recession begun in 2007 and hit the climax in 2008 resulting into severe economic effects that saw many businesses and multinational companies shut down (Taylor, 2009). Economically, financial crisis can be explained via the monetary policy tools because excesses in the economy are the contributing factors to the financial crisis (Fox, 2008). The excessive money in the economy increased the purchasing power of the consumers and this was translated into a boom in the housing sector since customers were able to obtain credit from financial institutions in order to service their mortgages (Fox, 2008). This paper will briefly outline and provide an explanation of some of the government intervention measures in the economy that led to the financial crisis. This will be followed by the analysis of how the financial crisis has led to the US and Japanese governments’ reassessment of such economic interventions (Fox, 2008). One of the contributing factors to the financial crisis in the United States was the government’s intervention in the economy through expansionary monetary policy that led to excessive money supply in the economy (Shalal-Esa, 2008). For example, the Federal Reserve Bank held interest rates low between 2003 and 2005. This led to excessive borrowing of money from financial institutions by consumers. Consequently, the housing sector recorded the highest growth ever due to the increased consumer power of spending. According to studies from the Economic Cooperation and Development Organization, excessive monetary supply in any given economy results into a housing boom because consumers are more sensitive in real estate investments than other types of investments (Shalal-Esa, 2008). Hence, excessive low rates of interests increased the consumers risk taking tendencies resulting into rapid rise of house prices. The other contributing factor that accelerated the financial crisis as a result of government intervention in the economy in the US was the 2008 Economic Stimulus Plan that led to the injection of more than $100 billion into the economy to help families and individuals in order to jump-start consumption among the consumers in the US (Shalal-Esa, 2008). However, this was against Milton Friedman’s theory of permanent income that argues that temporary rebates do not motivate consumers to increase their consumption (Kopecki, 2008). Hence, the desired consumption levels were not achieved. As a matter of fact, these intervention measures increased money supply in the economy that has seen the rate of inflation continue to rise in the recent past (Kopecki, 2008). The interventionally measures taken by the government to save the US economy during the financial crisis did not yield the desired fruits and thus the government has carried out a reassessment of its intervention in the economy following the financial crisis. From neo-liberalisation point of view, fiscal discipline, tax cuts and free market are some of the intervention measures that can be undertaken by the government to liberate the economy from economic crisis. In order to liberate its economy from the financial crisis, the United States applied the aspect of free market where forces of demand and supply were allowed to shape the rates of interests that determine borrowing from the public (Waggoner & Lynch, 2008). For example, the market forces of demand and supply are now responsible for the operating interests’ rates in the US economy (Waggoner & Lynch, 2008). Second, reducing the rate of interests below the monetary guidelines has also been reassessed in order to reduce excessive money supply in the economy. This follows the realization that the government’s intervention in the economy between 2007 and 2008 led to the reduction of interests’ rates from 5.35% in 2007 to a record low of 2% in 2008 that led to excessive borrowing (Waggoner & Lynch, 2008). This was followed by an economic boom in the housing sector that paved way for an economic bust later in 2007 and 2008 (Waggoner & Lynch, 2008). The reduction in interests’ rates also led to dollar depreciation and subsequent increase in prices of oil. Hence, the government intervention through reduction in interests’ rates resulted into a trickledown effect in the economy that made life unbearable and desperate for Americans (Waggoner & Lynch, 2008). In summary, the US government intervention in the economy through reduction of interest rates below the monetary guidelines was fuelled by the need to increase liquidity in the economy. However, the injection of $100 billion following the 2008 Economic Stimulus Act led to the worsening of the crisis (Robert, 2008). In this regard, reassessment of the government intervention in the economy has been performed particularly raising the interests’ rates above 5.35% to discourage borrowing and reduce the amount of money in the economy (Robert, 2008). In Japan, some of the interventions undertaken by the government that caused the financial crisis or accelerated the financial crisis include were both fiscal and monetary oriented (Okimoto, 2008). One of these interventions was the reduction of rate of interests to 0%. This was possible because Japan’s political economic system is characterised by developmental state directed model. This means that the state and businesses are committed to structuring and directing of the economy. In this perspective, there is little reliance on free market mechanisms. As a result, Japanese government intervened by increasing aggregate demand through government spending. It is imperative to note that these policies aimed at increasing the aggregate demand did not achieved the desired results. The reason for this is that Japan plunged into a liquidly trap because even after lowering rates of interests to 0%, consumers were not willing to borrow because prices of assets were falling (Okimoto, 2008). Hence, the assets and other investment opportunities proved unattractive to the consumers. Additionally, the increase in government spending was poorly channelled to the economy resulting into insignificant real effects in the economy. A negative equity effect resulted due to the falling prices of assets (Pettinger, 2008). The consequences of the Japan’s government intervention in the economy through monetary and fiscal policies such as reduction of interest rates below 0% to encourage borrowing and increase in government spending can be summarized as follows; The developmental state directed-model of intervention led to stagnation of economic growth for a long period which has deteriorated further due to recent effects of the earthquakes in the country. The other consequence is that the rate of unemployment in the country has increased drastically to over 5% in the recent past due to slow economic growth and expansion of industries (Pettimger, 2008). Increased rates of homelessness in the country because banks and other financial institutions are still reluctant to lend due to the stagnant economic growth. As a matter of fact, during the financial crisis banks incurred huge losses due to the increased rates of defaults catapulted by falling asset prices that proved unattractive to investors. The short term projection about the rise of asset prices was not forthcoming and thus banks created difficult conditions for lending. Various reassessments of government interventions in Japan have therefore been undertaken in order to revamp the economy. One of the major reassessments undertaken by the government in Japan is instituting proper mechanism for addressing structural problems in the economy before applying the developmental state-directed model to solve the problems in the economy (Okyumi, 2011). For example, the government has reduced the political nationalist goals aimed at driving economic management such as reducing government spending and leaving markets forces to regulate the rate of interests. Furthermore, the other reassessment undertaken by the government include reduction of monetary support or bailing out of ailing firms because bailing out ailing firms during the financial crisis did not yield positive results. This has been substituted by increasing and promoting international competitiveness of goods produced by Japanese companies in the international market. The government has also undertaken a reassessment of its policies in order to avoid reliance on data from a single sector such as the housing sector to make major investment decisions (Pettimger, 2008). The reason behind this reassessment is that just like in the US, the Japanese government relied on data from the booming housing sector to make far reaching economic decisions ignoring the performance of other sectors of the economy. As a result, the economic bust that followed the boom resulted into far reaching economic effects such as bankruptcy of firms and the subsequent loss of employment opportunities. References Fox, J. (2008). “Why the government wouldn’t let AIG fail. New York Times Kopecki, D. (2008). “US consider bringing Fannie, Freddie on to Budget” Bloomberg. Okimoto, D. (2008). Causes of Japan’s Economic Stagnation: 1999 to present. APARC. http://aparc.stanford.edu/research/causes_of_japans_economic_stagnation Okyumi, G. (2011). Major Interventions by government in Japan that led to financial crisis. New York Times. Pettimger, T. (2008). Japanese Financial Crisis. Economics. http://econ.economicshelp.org/2008/10/japanese-financial-crisis.html Robert, C. (2008). “Financial crisis: Someone will have to dig us out of this debt” Daily Telegraph. Shalal-Esa, A. (2008). “Fact box: Top ten US bank failures”. Reuters Taylor, J. (2009). How Government created the Financial Crisis. The Wall Street Journal. http://online.wsj.com/article/SB123414310280561945.html Waggoner, J., & Lynch, D. (2008).” Red flags in Bear Stearns collapse.USA Today. Read More