Fiscal and Monetary Policies in the 2008 Recession

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Fiscal and Monetary Policies in the 2008 Recession

The United States experienced a recession in 2008, which extended to other European countries. According to Bargain et al. (2017), recession refers to a considerable reduction in economic activity within a particular economy, which lasts for many months. It is normally visible in real gross domestic product (GDP), employment rate, wholesale-retail purchases and sales, manufacturing production, and real income. The 2008 Great Recession emanated from high-risk loans granted to borrowers with negative credit histories due to housing boom in America. As a result, mortgage lenders aiming at capitalizing on the increasing housing prices approved loans while observing less restrictive terms for borrowers. With the continued rise in home prices in Western Europe and North America, other financial institutions bought bulk mortgage-backed securities as investments, hoping to earn profit quickly. Sadly, the decision to acquire huge mortgages led to economic catastrophe, causing the 2008 Great Recession. However, the federal government used fiscal and monetary policies (demand-side strategies) to mitigate the recession, thus lessening unemployment and restoring economic growth.

First, the federal government reacted swiftly to use the monetary policy, which focused on reducing interest rates to improve borrowing and investments. As the employment rate and GDP fell drastically, the Federal Reserve diminished the federal funds rate to about 0-0.25% in December 2008 from 5.25% in September 2007 (Brakman & van Marrewijk, 2019). The federal funds rate denotes the interest rate, which the banks charge to lend and borrow their excess reserves among themselves for overnight loans. As a result, banks increased borrowing among themselves, leading to increased money to lend to the Americans for investments. Indeed, the low federal funds rate meant banks would also lower the interest rates charged to borrowers. Therefore, this monetary policys primary objective was to reduce borrowing costs for businesses and people, thus inspiring direct investment and consumption, increasing aggregate demand. Notwithstanding, reducing interest rates could only reach a specific limit and could not extend further due to the severity of the 2008 Great Recession. Consequently, the federal government had also to consider fiscal policies as practical recession-fighting strategies.

Significantly, the federal government adopted fiscal policies, including government spending and cutting taxes to increase aggregate demand levels. For instance, the federal government reduced income taxes to increase spending. Indeed, it granted $282 billion in tax cuts, increasing employees disposable income (Bianchi & Melosi, 2017). With this rise in salary, Americans were inspired to increase their consumption, thus shifting the aggregate demand curve to the right, necessitating a higher output level. Besides, producers enjoyed tax cuts, which lowered their production costs. In return, businesses and industries increased their production level to meet the escalated demand at considerably lower expenses. The reduction of taxes on goods and services also promoted their affordability, thus prompting consumers to increase their purchases.

Additionally, the federal government utilized a stimulus package to increase its spending. Fortunately, Congress reacted on time and approved the American Recovery and Reinvestment Act (ARRA) in 2009 (Schanzenbach et al., 2016). This Act played an indispensable role in fiscal stimulus by authorizing spending on education, infrastructure, and healthcare. According to Bianchi and Melosi (2017), the $787 billion stimulus package helped stimulate aggregate demand, thus creating jobs in different sectors. President Obama also initiated a homeowner stability initiative, which was allocated $75 billion to assist 9 million people projected to own homes before the onset of the Great Recession (Schanzenbach et al., 2016). As part of the stimulus package, the federal government invested in unemployment insurance (UI) and temporary assistance for needy families (TANF) programs. Although not every American was eligible for UI, it accomplished its mission in cushioning the newly unemployed against substantial earning losses. Correspondingly, TANF assisted in mitigating absolute poverty in families with dependent children. These two programs helped in increasing the available money for consumption, thus raising aggregate demand.

The fiscal stimulus through ARRA contributed significantly to the alleviation of the severity of the 2008 Great Recession. Based on the congressional budget committee (CBO), the fiscal stimulus bill led to a GDP increase from 0.4% to 2.3% by 2011 (Schanzenbach et al., 2016). In the American context, stimulus directed to cash-constrained or low-income households was more effective than business tax cuts. Although the latter encouraged increased production levels, stimulus directed to key sectors such as healthcare, education, and infrastructure created job opportunities, thus lessening unemployment and promoting consumption. The employment rate has nearly returned to its trajectory before the onset of the recession. Nevertheless, despite the monetary and fiscal policies undertaken to alleviate the Great Recession of 2008, the output level has not reversed to its pre-recession trend.

The 2008 Great Recession adversely affected the American economy by reducing real GDP and increasing unemployment. The high-risk loans granted to borrowers without the necessary restrictions led to the recession. Fortunately, the federal government reacted swiftly through Congress and passed critical fiscal policies, including government spending and tax cuts, to alleviate the situation. For example, reducing taxes led to an increase in workers disposable income, encouraging consumption. On its part, government spending stimulated aggregate demand in different sectors such as infrastructure, thus creating employment. Besides, reducing interest rates, as a monetary policy, helped to increase borrowing, promoting higher consumption and investments. Irrefutably, the monetary and fiscal policies combination played an indispensable role in shifting the aggregate demand curve to the right, increasing production and job creation. Although the output level has not reversed to its trajectory before the recession, the policies successfully mitigated extreme economic consequences.

References

Bargain, O., Callan, T., Doorley, K., & Keane, C. (2017). Changes in income distributions and the role of taxbenefit policy during the Great Recession: An international perspective. Fiscal Studies, 38(4), 559-585.

Bianchi, F., & Melosi, L. (2017). Escaping the great recession. American Economic Review, 107(4), 1030-58.

Brakman, S., & van Marrewijk, C. (2019). Heterogeneous country responses to the Great Recession: The role of supply chains. Review of World Economics, 155(4), 677-705. Web.

Schanzenbach, D., Nunn, R., Bauer, L., Boddy, D., & Nantz, G. (2016). Nine facts about the Great Recession and tools for fighting the next downturn. Brookings.

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