The 2008-9 Recession and the Effects It Had on the Economy - Case Study Example

The 2008-9 Recession and the Effects It Had on the Economy 1 Describe the 2008-9 recession and identify the effects it had on the economy. Recession can be interpreted as a complex relationship of increasing costs, decreasing property prices, and personal debts (Smith, 2008). The economic recession from 2008 to 2009 ate up the government finances rapidly. It had its major impact in the UK and the USA as compared to the Eurozone. Considering its effect on the economy from the case study, it can be seen that the GDP growth rate and hence the GDP of the UK, the USA as well as the Eurozone was severely affected in this era. According to the data presented, it has been observed that the year of 2006 faced a sever downfall in the GDP growth rate of the Eurozone, the UK and the USA. The annual percentage change has been recorded to as far as -4. After 2009, the graph slowly increases to -2 to finally cross the graph for a positive figure in 2010.Dividing it by quarter, figures state the specified areas were affected till -3.0 which began its decline in 2008. The recession also presented worrisome figures regarding the unemployment percentage and states a percentage of nearly 5 percent in 2007 later increasing to almost 9 percent in the USA, 7 percent in the UK and more than 9 percent in the Eurozone due to recession hits. The recession thus affecting the economies sent the already in deficit economies more into the financial crisis; a fast reduction of finances of the government was observed. This condition was seen as the worst in the USA and the UK whereas the Eurozone experienced this condition one notch below. The deficits recorded for the UK hit the mark of 11.4 percent while the USA and the Eurozone faced deficits of 11.5 and 6.4 percent in the year of 2009. Government finances depreciate during periods of recession and deteriorate when growth slows or the economy contracts. Recession lead to a decrease in income, less expenditure, and lower profits which all fed through into low government revenue. It was also observed that the government expenditure became higher due to an increase in the unemployment ratio; correspondingly employment was lower among the population thus resulting in a lower income of people. When the economy was weakening in 2008 to 2009, the government faced a barrier when aiming for a surplus; the government focused on a surplus and by doing this its revenue exceeded expenditure to reduce the government debt. This was very important because when the economy went into recession, the government’s financial position deteriorated very quickly. By doing this, the government saved its revenue from falling as income, expenditure and profits fell, expenditure rose along with the unemployment. So when the economy slowed the government went into deficit with expenditure exceeding in taxation. 2 Explain how fiscal policy could be used to encourage recovery from the recession. There are ways to encourage recovery from the period of recession. To begin with, increasing expenditure is one option. In this way, a little extra money for the development is injected. This added money thus aids as a tool for the infrastructure projects, the education, health benefits as well as tax reliefs. The VAT can also be reduced like the US government did in the year 2008 from 17.5 to 15%. Also, reducing debts as well as the deficits is one option similar to the Eurozone economy that responded to the recession with the help of a fiscal policy. As of 2010, its stance had been neutral. The fiscal policy used, thus manages to bring the debt trend in momentum and ensures just the right percentage of the debt trends as well. Statistics state that the percentage of Gross Value Added in the Public administration, defence, education, human health, and social work activities followed an increasing trend from the year 2007 till 2010. Beginning with the 18% it gradually increased till 19.6%. As for the construction, the trend remained somewhat constant at 6.7 and then eventually reduced to 6.2%. The financial activities and insurance activities have also faced an increasing trend from 4.9 to 5.3% eventually. Linking it with the on-going recession, it has observed that the 2011 stance of the fiscal expansion had become restrictive. In 2011, it was observed that structural reforms were perused. These reforms were said to be followed in the areas of pensions, the labour market, product markets, and the services sector so that long-term sustainability of public finances could be ensured. Other than that, it was also ensured that the growth potential is increased in the economy. As for 2012, it is observed that the measures used for the fiscal policy were stricter than the previous years. More specifically, the debt trends were brought back in to the market so that the confidence could be restored. Further, the current policy is dealing with the recession by bringing the deficits back to 3% below of GDP with the help of an annual structural adjustment. In the times of recession, the fiscal policy works as a tool known as the expansionary fiscal policy and encourages recovery by reducing the taxes and increasing the spending done by the government. The times of recession thus forces the fiscal policy to introduce the era of deficit spending which is completely opposite to the budget surplus in the times of overheated expansion (Fiscal Policy vs Monetary Policy). 3 Consider the limitations on the use of fiscal policy, particularly at the moment. Considering the USA, UK and the Eurozone, they held a certain amount of debt to deal with recession. The debt is held domestically in order to make it sustainable. However, it has been observed that with the percentage of debt in relation to GDP increasing, the sustainability becomes more and more of a problem to deal with. This is one of the biggest limitations of fiscal policy at this moment. It is because of the fact that if such a situation comes, the government faces the problem of injecting money for interest as well as the ability to repay debts. When the fiscal policy is applied in times of recession, it must be made sure that in relation to the GDP, the stock national debt must be reasonable. Along with that it must also be made sure that the deficit should not become too large. In the times of 2008 recession and forward, the use of automatic stabilizers introduced a deficit stimulus and worked towards an increased spending. Of course if the scenario is different, then the effects would include a highly confused market. This is so, because the ability of the government to repay its borrowing becomes highly doubtful and further borrowing would become questionable. If inflation needs to be avoided, the government basically works by borrowing money from the economy. Further, the money cannot be taken by the government itself. This is so, because the government would then require the central bank to print money for itself for spending. Of course, even this approach has limitations and its own implications; it has been observed that as the government increases its borrowing, the budget deficit keeps on increasing. Further, as the borrowing level goes up, the level of interest rates in the economy also rises. However, this effect does not stop here, borrowing and hence the financial system sucks the money from the companies which further reduces the level of investment in the private sector. The situation can also be worsened if the expenditure by the government is spent over the consumption instead of the investment. 4 Explain how conventional monetary policy could be used to encourage recovery from the recession. In times of recession, the monetary policy manages to hit the interest rate and changes it. This means, that the overall money supply is changed. This policy is used to adjust the interest rates as well as maintaining a firm focus over the inflation targets. This policy is thus used in the times of recession by looking at the real interest rates because the ability to pay back the loan is often amplified. This means that as the inflation increases, the real value of the loan decreases and the revenue of the business and the income of households rises with inflation. When recession arrives, the effects of monetary policy are reduced to a great extent. This is so, because the monetary policy aims to affect the interest rates as well as the price availability, which means the money supply and the price of credit is directly affected. Of course both of these are interrelated as a tighter control over the money supply works towards increasing the interest rates. Still, it has been observed that the money supply and economic activity do not hold a stable relationship between each other. This policy is usually under the control of the central bank also known as the Federal Reserve System. In times of recession, this policy is used to help the economy by lowering the interest rates and making the money supply go higher. It must be understood that as inflation sets in, the real value of loan becomes near to zero. It so happens that when the government purchases bonds, money into the economy is increased. In return, the banks hands the government the ability to lend more as reserves are held less than the deposits. Due to this, in times of recession, expansion and investment by businesses increase, the mortgage rates reduce and, disposable income increases (Fiscal Policy vs. Monetary Policy). 5 Consider the limitations on the use of conventional monetary policy in these circumstances. In times of recession, although the monetary policy might help the economy for a while, but in the long run it becomes difficult to hold on to it. This is so, because interest rates do not usually hold a negative figure and when it comes near to zero, its implementation cannot be carried out anymore. In such circumstances, individuals do not aim towards increasing their borrowings. Statistics state the same condition in the case of the Eurozone, the UK and the USA as their official rates were seen near to zero. Another condition that can be pointed out after recession hit these countries is the decrease in borrowing. These problems had been very apparent in the Eurozone, the UK and the USA. According to data, the environment has been further worsened by the high level of debt recognized in the household scenario. With such condition in the UK and the US, it was also observed that the debt level was significantly increased. Another example when it comes to discussing the limitations of the monetary policy is of Germany where the policy manages to paint a picture of reduced household debts and only a marginal rise in business debts. However, sources confirm that the US had been the most successful in reducing these debts. Although this policy can limit the time span as well as the severity of the economic recession, the authenticity of such a claim is under debate. It might happen that the aim of initiating consumer spending when the interest rates are lowered as there might be no confidence left in the consumers. The spending can also be hampered when their jobs are at risk. As for the businesses, investment becomes affected and banks become reluctant to increase lending. Lastly, the time frame in which this policy starts affecting is too large as the affects cannot be immediately felt. 6 Explain what unconventional monetary policy has been used and how this was supposed to work. The unconventional monetary policy works by injecting increased money supply into the economy and does so by the use of buying long term government securities or the government bonds as security. Considering the role of central bank here, they cannot buy the government debt directly. So in order to avoid such a restriction, the government buys such debt in the form of private holders. When it comes to discussing how this was supposed to work, the actions of governments of the UK as well as the USA can be stated. According to data, these countries managed to use the unconventional monetary policy to attain aid the deficits faced with low interest rates. The previous has been justified by the bank of England’s analysis with the fact that GDP rose from 1.5% to 2% while inflation was seen to be raised from 0.75% to 1.5% Also known as quantitative easing (QE),the aim of such policies can be stated in two points. One: the policy works towards decreasing the rate of interest in the long run and two:too much increase in the money supply in the economy. Therefore, this works by increasing the private lending and borrowing. Such lending has been limited by the demand as well as the supply. This is so, because in such a situation banks try to restore their capital and liquid reserves with the introduction of bad debts in recession. Such lending has also been limited because banks become affected by the presence of growing reserve requirements so that they could deal with the crises looming above. Such policies also work towards funding the government deficits at very low rates of interest, like it has been done in the past. 7 What are supply side policies? Consider the contribution these may make to resolving our current economic problems Supply side policies aim towards improving the productive capacity of the economy. These policies focus on making markets flexible and manage to tackle the market failure through reducing the intervention of government. Thus, these policies operate through shifting aggregate supply, and hence increasing productivity. It was observed that the BOP of the UK and the USA had been quite persistent to point out the presence of many macroeconomic problems in the time of recession. However, the presence of a deficit in the BOP is not sustainable in the long run because an increase in foreign indebtedness is observed. When it comes to financing overseas investment, the account of BOP is used by many countries in surplus condition. Assessing from the data available, it can be stated that these countries have been facing deficit in the BOP between the years 1999 till 2010. As for the Eurozone, their BOP account has also been seen fluctuating. The measures of exchange can also be mentioned when supply side policies are discussed. However, it has been observed that due to the presence of float in many currencies, it is difficult to measure the changes in the value of the currency. According to effective exchange rate indices, the dollar faced a decline in the times of recession whereas the euro’s graph showed an upward trend. The contribution these policies make towards resolving our current economic problems are low inflation, reduced unemployment, better economic growth, and improved trade and BOP. This means that as the economy becomes more and more efficient, the policies bring in the clause of cost push inflation. Also, these policies can help our current economic conditions by decreasing the natural state of employment through reducing the structural and frictional unemployment. The tools these markets use for efficient results can be achieved through the introduction of privatization, deregulation, and reduced income taxes. Also, by increasing the education and training, reduced power of trade unions and removing red tapes along with deregulated markets would yield good results for the economy (Economics Online). 8 Identify any differences between the Eurozone, the UK and the USA in macroeconomic policies adopted to encourage recovery from the recession. When all three of the countries experienced deficits, the response had been very different. To begin with the US government, although it had the highest deficit, it worked towards increasing expenditure with ‘The American Recovery and Reinvestment Act 2009’.The labour government reduced VAT from 17.5 to 15.0% in 2008, due to which gradual tightening began as economic conditions improved. The government believed these policies to be necessary so as to rebalance the economy from the public to the private sector. As for Eurozone, their main focus was to reduce deficits as well as debt. Debt trends were brought back so that confidence was restored through a sustainable path and brought deficits back to below 3% of GDP. Considering the UK policies, its government announced reduction in tax rates and introduced deregulation to aid businesses that are small in nature. Eurozone has aimed to achieve lower inflation rates stable in nature along with the interest rates and budget deficits. As for the USA, the policies stress on the financial strength and health care and aim towards making the market economy a market oriented economy. 9 Is there any evidence of different outcomes from these differences in policy? It has been observed that there has been a difference in growth in the Eurozone in the UK and the USA. Except, the trend has been quite misleading because of the fact that the financial services and construction went through an unsteady growth and the borrowing increased in the US as well as the UK. This is so because of the strong presence of the financial sector in the UK and US. As for the Eurozone countries like Ireland and Spain, a steady growth in the construction was observed. The economy of UK was also aided by the growth of public sector and a reduced figure in the unemployment zone. This zone was also seen to be changed in the USA and the Eurozone. Therefore, the unemployment levels were seen to be lower in UK and USA while in the Eurozone, this level was considerably higher (British Embassy Washington). Therefore it so happened that after the recession that worked towards shaking up the entire globe, a little recovery was experienced after 2009. Of course, with the countries implementing various policies, the outcomes experienced in the end of this period had been different. The year 2010 handed the economies faltering outcomes in the Eurozone and the UK but this was not observed in the US (Economic and Monetary Union). 10 Assess the political pressures and social issues that might constrain governments from following a purely ‘economic solution’ to their most pressing macroeconomic problems. To implement a pure economic solution is one of the most important factors in organizing any economic problem. As stated earlier, when the policies are being implemented, it might happen that the aim of initiating consumer spending might not be met as when the interest rates are lowered because there might be no confidence in the consumers. As for the spending, it can also be hampered, and the policies cannot be implemented the way they are supposed to be since most jobs of the individuals are at a risk. As for the businesses, it might happen that the investment becomes highly affected and banks become reluctant to increase lending, thereby making it difficult for the policy makers to effectively implement the perfect economic solution. The political pressures can be understood by the electoral system of the UK where a strong central control is favoured by the ruling party and it is made sure that it also involves treasury enabling taxation spending decisions so that a balanced budget can be ensured. Therefore, political pressures also affect the perfect economic policy to be implemented greatly (Flynn). References British Embassy Washington, UK & US: Key economic facts, retrieved from: http://ukinusa.fco.gov.uk/en/business/economic-relations/key-facts [Accessed 24 February 2012] Economic and Monetary Union, The European Integration, Retrieved from: http://www.xanthi.ilsp.gr/kemeseu/ch4/pol_E.htm[Accessed 24 February 2012] Flynn. N., Fiscal problems & Economic Performance in Department of Financial &Management Studies, Centre for Financial and Management Studies, (65). Research Summary, The Effects of Recession and Those Most at Risk, October 2008. Smith, D. Things Fall Apart: The Silent but Pernicious Effects of Recession, in ‘The Times’, 2008 Thomson. A, Why the Recession is a Blessing in Disguise, ‘The Times’, 2008 Read More