US Economy and the Recent Implications of the Global Economy Crisis Essay

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Global Economy Crisis (2008) for U.S. Economy

The economic crisis that was recently witnessed around the world including the United States and the various efforts that were made by the various governments in order to bring some stability to their economies, have raised questions on the strengths of free-market system and what informs interventions by the state. This paper's objective is to put into perspective the debate on interventions by the government and free-market efficiency. The paper also seeks to make a case for the need for regulating financial institutions so that economies are more stable (Aikins, 2009).

The economic crisis raised several questions on the place of the interventions states make in stabilizing economies as well as the strengths and weaknesses of the free market system. A lot of debate has been going on in this area. At the height of the crisis in 2008, various governments of industrialized countries, in fear that the situation may escalate further, took serious measures to ensure that the financial institutions that were facing financial turmoil in their nations did not collapse. The U.S. was at the forefront and made interventions to a scale that could be equated to the ones seen during the great depression (Aikins 2009).

Market Society and Laissez-faire Economies

The theory of laissez-faire economics is based on the model that production, be they of goods or services, is governed and controlled by the consumers who are deemed to be rational in the choices they make. An idealized competitive economy is characterized by self-regulation, free flow and availability of information as well as the revelation of preferences and exclusion. These factors of revelation of preferences, and assuming that individuals are rational in meeting their preferences, constitute what consumer sovereignty is based on. Only exclusivity when it comes to ownership and use of property can ensure the transfer of property and hinder people using goods and services they have not paid for (Aikins 2009).

The liberal self-regulating state of the 19th century lead to the emergence of 'market society' (Polanyi 1957, 250). The liberal state stood for influencers who were behind market focused institutions. When World War I ended, embedded liberalism replaced classical liberalism and market society. Embedded liberalism was focused on employment, growth and redistribution and was grounded on socialism (Ruggie 1983; Polanyi 1957). The need for the state to intervene in macroeconomics was reinforced during the great depression. The economy stagnating made it urgent that states make various interventions to guard against loss of employment (Gallarotti 2000). As Marx had predicted, in their efforts to protect their capitalist states from collapsing, the states adopted policies that they were against that encouraged the use of resources of other producers to better the position of other people so as to promote equity in the society (Aikins 2009).

Keynesian Model of Macroeconomics

Interventionist policies that started following World War I was intellectually legitimized by Keynesian Revolution which became popular during the period the great depression was ending. The war had taught the capitalist societies that a capitalist economy's crisis could be avoided through extensive public expenditure. John Maynard Keynes theorized later on what lessons had been drawn by the capitalist state (Aikins 2009).

Keynes had the belief that the goal of state intervention was complimenting market forces so as to achieve high economic activity levels as well as full employment therefore enhancing the productivity of the liberal market (Kethineni 1991). As a way of counteracting the reducing demand, Keynes made the proposal that governments increase their public works expenditure, especially on power projects, hospitals, roads, schools, etc. (Brown 1984). Most Western nations adopting the views of Keynan sought to achieve both goals of social freedom and justice (Mishra 2001). The measures taken ensured the stability of the economy and helped the economy grow (Aikins 2009).

A key argument in Keynesian theory of macroeconomics is nations using fiscal policy in countering recession by increasing government spending or lowering taxes so as to increase consumer spending. This means that governments can take various measures to alter demand in the market. The problem with these interventions is their vulnerability to political motives, and so, it is difficult to regulate (Aikins 2009).

Policy Responses

The financial crisis had serious administrative and policy implications as far as sound governance and economic and financial system is concerned. Every nation aims at making decisions that advances its needs and makes it achieve its goals.

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As Lehne (2006) argues, a society puts up political institutions that construct legal frameworks which guide the operations in the economy. The frameworks are a reflection of the political values of the nation. Political values always influence the markets and so it is not possible to divorce the markets completely from public policy and politics (Aikins 2009).

The U.S. made several monetary and fiscal responses to the 2007-8 financial crisis and the 2008-9 recession. Generally, the Federal Reserve's monetary responses were more effective than the fiscal policies of the Congress and the President which were often politically motivated and were not timely. It is unfortunate that this was the case because theoretically, fiscal policy should have had better effect (Blecker 2013).

Monetary Policy

Ben Bernanke, Fed Chairman, failed to recognize the extent of the damage that would be caused by the housing bubble, but immediately the extent became apparent, the Fed took unprecedented dramatic steps towards mitigating the situation and halt the recession from turning into the "the Great Depression" (Roubini and Mihn, 2012). Till mid-2007, Fed leaders always said that the impacts that the housing bubble had were possible to be limited to the housing sector. But towards the end of 2007, and particularly following the failures of AIG, Lehman Brothers and Bear Stearns in 2008, the Fed made the realization that the impact of the housing bubble were far reaching and would have an effect on the whole financial system from commercial banks, derivative markets, equity markets to insurance companies (Blecker, 2013).

In early August of 2007, as housing and stock prices were taking a hit, the Fed started reducing federal funds rate gradually. The rate of the reduction was heightened after Bear Stearns collapsed in March 2008. This was followed by an abrupt cut on the target rate to a figure close to zero after Lehman Brothers failed in September 2008. The Fed's target was closely followed by short-term T-Bills rates. So, short-term rates as well as policy rates have, beginning 2008, been at ZLB or near it. Effectively, monetary policy, as theorized by Keynes, is in a "liquidity trap" where expansionary monetary policy can't be made use of in lowering interest rates any more (Blecker 2013).

As the Fed made the realization that the recovery was slow and important markets like credit, housing and labor markets were depressed, a decision was made for more action to be taken to reduce lending rates and long-term interest rates. This was done through the policy of "Large Scale Asset Purchases" (LSAPs) also popularly referred to as "Quantitative Easing" (QE) (Blecker 2013).

The large-scale purchase of assets resulted in excess reserves in commercial banks. The reserves rose from insignificant figures before the crisis (usually below U.S.$2 billion from 2003 to 2007) to levels that had never been seen before of U.S.$1.1 trillion in Dec. 2008. In September 2013, the figure stood at U.S.$2.2 trillion. The huge increase happened as a response to Fed's actions but their remaining at such levels is an indicator of the slow growth in lending by the banks following the crisis. The banks hold the cash in the balance sheets in place of lending the money out. This explains the weak position of many households and businesses as far as expenditures are concerned during the recovery (Blecker, 2013).

Fiscal Policy

The government took 4 main fiscal policy actions which were originally designed to deal with the recession and the financial crisis and then ensure economic recovery afterward. The first two sets were implemented during President George W. Bush's term and the other two during President Obama's term beginning 2009. They were:

One-time personal income tax rebates, spring 2008;

Troubled Assets Relief Program (TARP), which was enacted in fall 2008;

The Obama stimulus package, 2009 -- 2010; as well as

Temporary extensions of some unemployment benefits and tax cuts, 2011 -- 2012 (Blecker 2013).

The policies had stimulative effects but they were short and small. The Republicans becoming the majority in the House of Representatives saw them mastermind certain artificial fiscal crises which forced the government to severely restrict federal spending and there has been a shift towards austerity when it comes to fiscal policy. Beginning with the Bush tax rebates, the expenditure was upwards of U.S.$150 billion but was insignificant as a proportion of GDP so there wasn't much of an effect on the recession which.....

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