The Affect of the Increased Government Spending to Combat Recent Great Recession - Literature review Example

The great Recession was between December 2007 and June 2009 although its effects are still felt today in the US economy (Perryman, 2016). Since then, the economy of the US has stagnated despite numerous fiscal policies adopted to avoid another recession. The rate of employment went down in the private and public sector making several people suffer especially the young graduates. The research focuses on the state of the economy of the US since the recession and how the policies implemented affected employment in the long-run. Another important consideration for the paper is to analyze the reason the US economy failed to recover completely making it necessary to consider policies that may help in achieving full employment. Of more importance is the understanding of the extent of the damage to the economy caused by the Great Recession especially the low demand for goods and services. The research will also focus on the lessons learned by other nations concerning the policies required to address issues related to economic development. Of great interest is the extent of the economic damage done by the recession and the methods of recovery applied and means that can help in taking the economy back to recovery. Stagnation of the US economy is a big problem that requires to be addressed to minimize the chances of the reoccurrence of another recession. This is because it can affect the entire world, as nations have become more dependence on one another. The government of the US has learned several lessons from the Great Recession and the measures they took to address them. The research will help in understanding the impacts of the policies to the economy, especially on employment and job creation.

Literature Review

The Great Recession and the policies by the US government have led to extensive research with many concentrating on the measures taken to address it and the effect on employment. Perryman (2016) argued that it led to long-lasting damage to the economy in particular on the labor market and the standards of living for many people. The assumption is that many families had to adjust their budget to suit their income as the demand for goods and services fell. This was worse for the first five years after the recession as the job gap is quite large. Recovering jobs that were lost during the recession was quite difficult in addition to challenges in creating new ones. The fiscal policies must be changed to those that encourage job creation to close the job gap expected to 2019. However, full economic recovery may take several years to achieve especially increasing employment rates and education attainment. According to the FocusEconomist (2016), the performance of the US economy is uneven although it was more resilient at the beginning of the year. The author assumes that most of the economic slowdown is due to financial policies that tend to address the symptom of recession instead of the cause. Exports and investments have deteriorated below although private consumption has risen. However, the growth is quite low compared to the expected rates with the GDP recording a rate of 0.8 percent, which is less than anticipated. According to this report, unemployment is still at 5.1 percent as the payrolls growth was quite low despite various fiscal measures taken by the US Government such as subsidies in the agriculture and other sectors. Notwithstanding these challenges, the US is still the largest economy, manufacturer, and a country with a high per capita income. Some of the problems the nation is facing include low rates of interests, increased mortgage lending, massive debts by consumers, and government regulation. The economy has received a lot of support through expansionary monetary policies such as low-interest rates and other unconventional practices such as purchase of financial assets to help in increasing the supply of money in the economy.

Mui (2016) writes that Fed's way of steering the economy is through regulating interest rates such as lowering them for encouraging consumers and businesses to spend more. This has the effect of boosting the growth of the economy, which is a serious concern. In addition, Fed increases incentives and restraints a surging economy for a similar purpose. Some officials are optimistic that the economy is recovering and will regain its full strength and Brexit will not affect it. According to the recently released data, the job growth in the US has slowed down especially in May 2016 questioning the power of the labor market. Curdia (2016) argues that Fed lowered the rate of federal funds to near zero to boost the economy of the US. The financial crisis has hindered the economy from achieving its full potential especially ensuring full employment and stabilizing prices. According to the standard monetary theory, lowering the short-term nominal interest rate stimulates the growth of the economy especially if there is low inflation in a country. Allowing inflation to be above the target in short-term can help in the economic recovery of the United States. However, this should not be prolonged as it may reduce spending and reduce the amount of money circulating in the economy.

Discussion

The US Government has applied several measures to solve the problems experienced after the Great Recession such as reduced interest rates, which makes it easier for people to borrow loans for investments. This has the effect of encouraging spending and investing increasing the aggregate demand and the growth of the economy. However, the AD may lead to inflation, which is a big concern for the US government. However, increased borrowing increases self-employment as people invest the borrowed funds. Unemployment is still an issue in the US since the rate has been quite slow than anticipated. The lower interest rate is also associated with cheaper borrowing costs, lower mortgage interest rates, rising asset prices, depreciation in the exchange rates. Lower interest rates should lead to an increase in the aggregate demand as per the equation AD=C+I+G+X-M by raising C, I, and (X-M), where households (C), firms (I), the government (G) or overseas consumers and business (X) changes (Economics Tuition Singapore, 2014). An increase in the AD led to a high GDP and Inflation and in 2009, cutting interest rates increased the growth of the economy of the US. However, for savers, disposable income is lowered thus, they tend to spend less.

From Economics Tuition Singapore, (2014)

From Economics Tuition Singapore, (2014)

The increase in the aggregate demand from AD1 to AD2 was facilitated by the decreased interest rates leading to an increase in the wealth of the consumers and the rise in the prices of housing in the US. A similar case is seen in the supply curve shift in which an increase in the price of commodities leads to increase in supply due to high profits. The shift could also be due to the fiscal policy has government increased spending, welfare benefits, taxation. Once people have high disposable income they can buy, more and suppliers have to increase goods and services in the market.

Conclusion and Recommendations

The US economy has faced difficulties in reaching a full recovery to the state it was before the recession. Policymakers have the responsibility of pulling every macroeconomic policy lever, which has the effect of increasing the aggregate demand for the nation. This entails targeting of bigger budget deficits for financing investments that create new jobs. In addition, there is the need to adopt unconventional monetary policies such as making an announcement of higher inflation targets and buying of long-term debts. This can help to lower interest rates that are of long-term, which can assist in stabilizing the nation's currency. The American recession problem may need vital measures its full recovery especially restoring its full employment. Conventional monetary policy alone may not work for the government and the nation thus; policymakers need to come up with a better way of dealing with the situation. The government must aim at closing the output gap since economy is estimated to operate 5 percent below its potential output capacity since the recession (FocusEconomics, 2016). The economy must grow beyond the growth of the labor force and the high productivity. Faster growth is required if full employment is to be restored in the United States through policy change. Additional fiscal support is necessary to close every gap while monetary policies such as lowering interest rate. Fiscal policies that may help improve the US case include an increase in taxation and reducing government borrowings. Monetary policy may play a significant role in improving the US economy and should be adopted. Since monetary policies have not solved the problem, the government should think otherwise an offer fiscal support. The government may raise its spending and use budget deficit for its financing in addition to lowering tax rates on the disposable income to encourage spending. If the government spends more on welfare benefits for its people, there is an increase in the transfer payments especially if the recipients use a high percentage of funds they receive. Increasing exports and improving relations with overseas countries will help in increasing incomes through increased sales to other nations. The government should also consider expanding output gaps over the medium and long-term to ensure a return to full employment by applying fiscal policy. The government should aim at improving work incentives and ensuring that controls are relaxed on an inward migration of labor to expand the energy supply. This will help in solving the problem of the aging population in the labor force to increase productivity. Labor mobility is also good, as it will enable unemployed population to move elsewhere and acquire a job instead of waiting for an opportunity to arise. The other possible ways of recovering the economy may include increasing investment and research to improve quality of goods for export. There is a need to expand the capital markets, stimulation of innovation and invention, increasing business efficiency, and other measures that can help in creating new goods and services that attract high demand. The US policymakers must commit themselves to finding a solution to the problems posed by the Great Recession such as unemployment. Government spending may be on state-provided goods and services in addition to public and merit goods.