Government Role in Fiscal Policy and Recession

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Government Role in Fiscal Policy and Recession

Table of Contents

Responsibility of Crisis
Monetary Policy Relationship to Fiscal Policy
Authoritative Policy Making
Bodies Limited to Persuasion
Is the Fed an Independent Body?
References

Responsibility of Crisis

A number of factors may have triggered the 2008 financial crisis. But the factor that stands out the most is the shortfall in liquidity that was witnessed by major banks around the United States. This shortfall was preceded by a phenomenon rise in need for houses. The increased demand for houses encouraged banks to offer more and more loans to prospective homeowners to purchase houses. The reason for this was the fact that interest rates were going to rise slowly and the owners were going to dispose off the houses and make a profit. The profit would be used to repay for the house loans (Krugman, 2009).

However, this did not materialize. Interest rates started rising in phenomenal way at the beginning of 2007 without stopping. On the other hand the price for houses started falling. This meant that the owners could not dispose off the houses and were therefore unable to repay the loan to the banks. The effect was like a web as it also meant that the banking system in America lacked liquidity to enable it to carry out its immediate operations. Hence, the financial meltdown that followed.

The big question is why it was so easy for American banks to offer loans to prospective homeowners. Was it because of the easiness that has been propagated by the American laws or was it because of the carelessness and greediness of the owners of the banks? firstly it is known that the laws that govern offer of credit in America are not strict enough which means people may take loans and use them else where. But this was not the cause. The executives of the banks and their desire to make quick profits were the main contributors to the financial crisis that grappled the United States markets in 2008 (Krugman, 2009).

Monetary Policy Relationship to Fiscal Policy

In economics there are two types of markets: the goods and the financial markets. A government in its regulation of the financial and economic situation of the country may use either of the markets to accomplish that goal. Monetary policy mainly focuses on the instruments that governments use to control the borrowing rates and money supply. It ca either be expansionary or contractionary depending on the variable that has been tampered with and the target of its implementation.

A contractionary fiscal policy has the effect of reducing the supply of money in the overall economy or increasing the interest rates. On the other hand, expansionary fiscal policy increases the amount of money supply in a country and reduces interest rates. The aim of implementing expansionary fiscal policy is to deal with the issue of unemployment in cases where the economy is undergoing a recession. This was the case after the 2008 financial crisis which bedeviled many governments the world over after originating in the United States. The aim of implementing contractionary fiscal policy is to tackle rising inflation rates.

Fiscal policy is adopted where the government increases its spending. In macroeconomics this always has a multiplier effect. This is because of the government multiplier which unlike other multipliers has a great effect on the spending habits of people. Increased spending by the government increases the disposable incomes of people and they reciprocate by spending more. This spending in increases demand fro more products hence output. The firms that are involved in production demand more labor and hence employment is created and the economy grows (Zelizer, 2004).

Authoritative Policy Making

Economic policies are majorly the responsibility of the fed. Federal Reserve is the body mandated with coming up with fiscal and monetary policies, regulation on both the banking system and financial system. It also regulates other microfinance institutions and is the body responsible for advice to the president on matters relating to economic policy and decisions. However its powers are derived from the united sates congress and it is not directly answerable to the president for any decision it makes. However, a presidential representation in the treasurer ensures that the presidents wishes are met (Beckhart, 1999).

Bodies Limited to Persuasion

When fiscal policy is in question in the United States some bodies in the government are limited to persuasion. One of them is the House of Representatives. This house, from which the fed derives its authority, can only discuss and approve or disapprove with the feds decision but cannot be in a position to change it. However, this offers it power to greatly influence the end fiscal policy.

The executive branch of the government can only bring fort ideas on how the usage of public money is to go about. These ideas are majorly vetted by the senate and the final decision made on the application of the ideas. Therefore, it is an integrated web of functions which fall in the responsibility of many government departments. But it can be clearly seen that the senate is left to just persuasion when it comes to making such policies and even their implementation (Hafer, 2005).

Is the Fed an Independent Body?

The fed is headed by a chairman. The president also appoints seven members of the board of directors of the fed. Although the governors are expected to serve in the next 14 years after their appointment and confirmation by the senate, it is apparently true that they act as the interests of the president and the majority party. The chairman of the fed can serve only four years after being appointed and confirmed by the president. He has a big role to play in the final decision and is directly answerable to the president and his advisor on economic matters. All these factors combine to weigh in the fact that the fed is not independent at all. The chairman will act in the interest of the president and will influence others towards the wishes of the current government (Zelizer, 2004).

The decisions made by the fed are not reversible by any body other than the House of Representatives. This house, if it has more of the ruling party members, can reverse that decision and offer recommendations on the changes they deem fit. In the end the fed decision will have been influenced by that body. Therefore, the only way to regulate this kind of scenarios and make the fed independent is by having an unbiased congress which will oversee the actions of the executive. This was achieved in the just concluded midterm elections in the United States. This will make decisions more inclusive but it will not, in any way, add onto the independence of the fed which is not there no matter which angle you look at it (Zelizer, 2004).

References

Beckhart, B. (1999). Federal Reserve System. New York: American Institute of Banking.

Hafer, R. (2005). The Federal Reserve System: An Encyclopedia. New York: Greenwood Press.

Krugman, P. (2009). Revenge of the Glut.

Zelizer, J. (2004). The American Congress: The Building Of Democracy. Texas: Houghton Mifflin.

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