Ricky De Gove

Running head: DEMAND-SIDED POLICIES AND THE GREAT RECESSION OF 2008 Demand-sided Policies and the Great Recession of 2008 Student’s Full Name Institution 1 DEMAND-SIDED POLICIES AND THE GREAT RECESSION OF 2008 2 Contents Introduction ................................................................................................................................ 3 Fiscal Policy ............................................................................................................................... 4 Monetary Policy ......................................................................................................................... 4 Conclusions ................................................................................................................................ 5 References .................................................................................................................................. 6 DEMAND-SIDED POLICIES AND THE GREAT RECESSION OF 2008 3 Introduction An economic recession is usually described as a slowdown in economic activities for two or more consecutive quarters (half a year or more). Economic activities include the production, distribution and consumption of goods and services. Therefore, a decline in production will lead to a decline in employment, which in turn will cause household income and household consumption to decrease. This sequentially forces companies to produce less, thus creating a vicious cycle. It is important to notice that, even though not all economic agents experience a decline in income during a recession, their anxiety and expectations about an uncertain future may affect their spending and investment, consequently leading to a decline in production. This means that economic recessions usually have a very important psychological factor linked to fear. People’s fear that the economy will slow down will cause them to spend less, consequently causing businesses to sell less. Low sales leads to a decline in production which in turn leads to companies hiring less people. Furthermore, less people employed decreases spending, generating a brutal and dangerous pattern. Alternatively, recessions can also be measured by other factors, such as retail sales and housing, but it generally takes longer for such data to manifest itself relevantly. Nonetheless, there are predominantly two major school of thoughts on how to end a recession. Keynesians claim that enormous government spending is the way to recovery. Monetarist state that the cure for a recession is fundamentally increasing the money supply. In the real world, a combination of both is usually the solution to the problem. This essay will discuss both briefly but in detail. The main focuses of macroeconomics are to aggregately measure the economy and to fix it if a problem presents itself. A problem such as a recession. In term of measures, the economy can either be in a recession, it can be at full employment, or it can have an inflationary gap. Moreover, there are fundamentally three actions that can be taken during a recession: No policy may be applied. This usually involves DEMAND-SIDED POLICIES AND THE GREAT RECESSION OF 2008 4 expecting the economy to fix itself. Alternatively, monetary policies can be used, and/or fiscal policies can be used to fix the economy. Fiscal Policy Fiscal policies focus on using a combination of government spending and tax policies to influence economic conditions. Economic conditions such as aggregate demand, employment, inflation and economic growth. Fiscal policy is largely based on the ideas of economist John Keynes. The British economist advocated the idea that governments could regulate and (most importantly) stabilize the economy by adjusting their spending and tax policies. These theories were a response to the Great Depression, which defied classical economics’ assumptions that declared that the economy would self-correct during a recession. Furthermore, fiscal policies can be contractionary or expansionary. Contractionary fiscal policies are used to slow down the economy by increasing taxes and decreasing government expenditure. Higher taxes, combined with a decline in government expenditure, leads to a decrease in spending and investment by households and companies, thus intentionally contracting the economy. However, during a recession, expansionary fiscal policies are in order. Usually this involves massive government spending as well as low taxes. This happens since during a recession, aggregate demand is usually low creating a gap, called a recessionary gap. Closing this gap involves the government increasing its spending and lowering taxes which will directly increase aggregate demand and (in theory) correct the economy. Monetary Policy On the other hand, monetary policy involves the monetary authority of a country manipulating the money supply and adjusting interest rates to influence economic activity. During a recession, the monetary authority (such as a central bank) can cure a recession by DEMAND-SIDED POLICIES AND THE GREAT RECESSION OF 2008 5 reducing the reserve ratio; lowering the discount rate, and; using its own money to buy government bonds and other financial asstes. The latter increases the government's income, which in turn translates to more money in the economy. Additionally, lowering the reserve ratio and discount rate increases access to money, leading to more attractive loans, thus increasing spending and investment in the economy. However, in the end, the action of the entire nation and its multiple economic agents influences the state of the economy, and no single entity, no matter how huge, can individually affect the overall economy. Conclusions The Great recession was a period of sharp economic decline that began in December 2007 and ended in June 2009. This lead to high unemployment rates which caused consumer spending to decrease dramatically. As a response to the recession, the United States government applied fiscal and monetary policies to fix the economy. In February of 2008 the government applied fiscal policy through a stimulus package. This allowed the government to attribute $152 billion dollars towards tax rebates as well as business incentives to stimulate aggregate expenditure. Also, on February 13, 2009, another similar package was passed by Congress, for the sake of creating and saving jobs and encouraging spending. Monetary policies, however, proved harder to implement since interest rates were 0%, limiting the Federal Reserve’s action, since a negative interest rate would prevent investment. Instead, the Federal Reserve purchased financial assets to increase the money supply. Such monetary policies were denominated Quantitative Easing. The policies used by the government and the Federal Reserve bank, even though highly criticized at the time, averted even greater damages. Their policies increased liquidity, which in turn increased aggregate demand, allowing the economy to recover. DEMAND-SIDED POLICIES AND THE GREAT RECESSION OF 2008 6 References Brewer, P. (2008). Can the government help in a recession?. Wise Bread. Retrieved 23 February 2018, from http://www.wisebread.com/can-the-government-help-in-arecession Cite a Website - Cite This For Me. (2018). Economicshelp.org. Retrieved 23 February 2018, from https://www.economicshelp.org/macroeconomics/as-essays/demand-sidepolicies-reduce-unemployment/ Demand-Side Policies And The Great Recession | Researchomatic. (2018). Researchomatic.com. Retrieved 23 February 2018, from http://www.researchomatic.com/DemandSide-Policies-And-The-Great-Recession86032.html#FreeMembershipVerification Demand-Side Policies and the Great Recession of 2008 - Essay. (2018). Essays24.com. 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