The 2007-2009 global financial crisis and its consequences are a key reminder of the complex nature of the financial meltdown. The crisis ranks as one of the most severe economic downturns to have affected the world since 1929. Despite the view that the origin of the 2007-2009 financial meltdown can be traced in the US, the effects of the crisis were global. Hence, numerous countries around the world were affected. Classes state that a financial crisis “is often an amalgam of events including substantial changes in credit volume and asset prices, and severe disruption in financial intermediation” (3). Financial crises can be categorized into four main groups that include banking, sudden stop, debt, and currency crises. Financial crises affect economies adversely, which underlines the significance of effective financial crisis management through the implementation of economic policies. However, the efficacy in managing a financial crisis is subject to the extent to which the issue is understood (Classens 3).
This paper examines different issues associated with the recent global financial crisis in the US. The paper reviews the role of the Federal Reserve in the economy during the financial crisis. The review focuses on the fundamental economic goals that the Federal Reserve is required to facilitate. An evaluation of the historic monetary and fiscal efforts [traditional and non-traditional] undertaken by the US government and the Federal Reserve in easing credit markets and stimulating the economy is undertaken. Further, the paper relates the US government and Federal Reserve involvement in the contemporary environment by identifying the critical measures that the incumbent Fed chairperson should focus on in the next 12-24 months. Finally, the paper assesses the position taken by some economists that the US economy is experiencing a ‘new normal economy’ due to the financial crisis.
The role of the Federal Reserve in the economy during the financial crisis
The Federal Reserve maintains a smooth economic environment by ensuring that financial institutions adhere to the stipulated laws and regulations. The global financial crisis prompted governments to implement unprecedented interventions in the quest to mitigate the adverse effects. The interventions undertaken by the Federal Reserve are aligned with the country’s commitment to achieving macroeconomic goals that include price stability, economic growth, and full employment. Subsequently, the Federal Reserve in the US undertook a critical role in averting the collapse of the economy. Through the monetary intervention, the US government was in a position to strengthen the level of stability. Rochon affirms that stability “is achieved by avoiding or limiting fluctuations in production, employment, and prices” (231). Pursuing price stability strengthens a country’s economy by promoting savings and capital formation. Additionally, price stability limits the likelihood of households experiencing a decline in their real purchasing power due to the inflationary pressure associated with the recession. Thus, price stability increases the level of consumption and savings hence stimulating the rate of economic growth.
In addition to ensuring price stability and financial market stability, the Federal Reserve focused on ensuring exchange rate stability. This goal was largely achieved by focusing on the monetary policies aimed at regulating capital flows. Therefore, during the financial crisis, the Federal Reserve was concerned with improving the level of investor confidence. Mishkin affirms that the stability of a country’s financial system is affected adversely by a financial crisis hence reducing the degree of investor confidence (60). Therefore, attracting investors in a country’s financial markets is limited significantly. This aspect underscores the rationale behind the Federal Reserve’s decision to implement the conventional and non-conventional expansionary monetary policies.
The implementation of the expansionary monetary policy cushioned the US economy from experiencing a liquidity trap (Rochon 231). By easing the interest rates, the Federal Reserve made it easy for investors and households to access credit from the financial institutions hence stimulating economic growth. The outcome of this move is that the Federal Reserve increased the chances of the US economy to attain full employment through the creation of jobs.
Monetary and fiscal efforts by the US government to stimulate the economy
During the financial crisis, the US government implemented different discretionary monetary policies. Ahmed and Alam define discretionary monetary policy as “a type of monetary policy used by the central bank at its discretion when the government gives autonomy to the bank to regulate monetary policies” (165). The interventions entailed different actions such as the implementation of non-conventional monetary policy, easing the monetary policy to cope with the rising rate of inflation, the provision of new lending facilities, the adoption of large-scale international swap arrangements, and quantitative easing (Hendrickson 193).
The interventions were aimed at promoting stability within the country’s banking system, improving the level of confidence amongst investors and households, and reviving the economy. Hendrickson accentuates that easing monetary policy offsets the negative consequences that originate from monetary turmoil (193). Similarly, Mishkin supports the implementation of conventional and non-conventional monetary policies during a financial crisis (78). In his opinion, Mishkin affirms that financial crises are characterized by inherent macroeconomic risks that might increase financial distress hence limiting the performance of the real economy (54).
The Federal Reserve designed different new credit facilities to improve liquidity at a relatively low rate of interest. For example, Fed implemented the Term Auction Facility [TAF] that was aimed at auctioning Fed funds. The TAF provided banks with an opportunity to obtain funds from other financial institutions at a competitive rate, which is relatively lower than the stipulated discount rate.
The Federal Reserve further adopted the concept of international central bank cooperation. During the financial crisis, the Federal Reserve adopted the role of being the lender of the last resort in the international market. To achieve this goal, the Fed established swap lines for the Swiss National Bank and the European Central Bank. The cooperation with these banks was aimed at allowing the foreign banks to borrow dollar loans from the US central bank.
The non-conventional monetary policy involved an open market operation in facilitating trade in short-term government securities. During the 2007-2009 financial crises, the Federal Reserve integrated the concept of Large Scale Asset Purchases [LSAPs]. Through this approach, the government expected to lower the rates of interest applicable to certain types of credit. For example, the LSAPs were applied within the mortgage-backed securities market [MBS] and residential mortgages. The Fed formulated the Government Sponsored Entities Purchase Program through which it purchased mortgage-backed securities valued at $1.25 trillion. Freddie Mac and Fannie Mae guaranteed the MBS. This program was largely referred to as quantitative easing. Quantitative easing was further achieved by purchasing Treasury securities worth $600 billion. The purchase was aimed at lowering long-term interest rates. The program contributed to an improvement in the functionality of some credit markets. The government’s effort to stimulate the economy further focused on the money market. The rationale for supporting the money market was aimed at stimulating the level of investor confidence (Ahmed and Alam 118). The government also implemented the Temporary Liquidity Guarantee Program [TLGP] to stimulate liquidity within the banking sector and investor confidence. These programs constituted a key component of the US bailout plans.
In addition to the above approaches, the US government implemented comprehensive supervisory actions. For example, 19 of the largest banks in the US were placed under the Supervisory Capital Assessment Program to facilitate the administration of stress tests. The stress tests were aimed at determining the level of market confidence, and thus the need for recapitalization hence stimulating stability within the financial market.
Fed and the US government involvement in the present-day environment and the measures that the Fed should pursue in the next 12-24 months
Currently, the US government is committed to restoring the country’s economy by promoting economic growth. The US government in collaboration with the Federal Reserve should focus on the most appropriate fiscal and monetary policies to improve the diverse components of the Gross Domestic Product [GDP] over the next 1-2 years. First, the government should consider increasing the level of consumption. One of the fiscal policies that the government should consider is adjusting the tax rate downwards. The outcome of this move will increase the consumers’ purchasing power. Consumer spending accounts for approximately 67% of a country’s GDP. Therefore, increasing the rate of consumption will promote growth in different economic sectors. This aspect will arise from the view that the demand for different goods and services is increased substantially. Therefore, the Federal Reserve chairperson should consider adopting tax cuts as an approach to spur economic growth.
The Congressional Budget Office [CBO] estimates the level of federal spending to increase from 20.4% of the country’s GDP in 2015 to 22.1% by 2025. Similarly, tax revenue will grow from 17.7% of the country’s GDP to 18.3% within the same period. Thus, tax revenue will increase by a margin of 0.6% as opposed to that of federal spending, which is estimated to increase by 1.7%. These differentials show that the country’s capacity to generate tax revenue to sustain government spending is limited. To sustain the level of government spending, the US government and Fed may be forced to increase the rate of interest and tax hence reducing the rate of economic growth.
Given this projection, the US government should consider reducing the level of government spending. This aspect will safeguard the country against budget deficits, which lead to an overreliance on borrowing to fund government programs. On the contrary, the government should focus on implementing measures aimed at stimulating investment and consumption.
Evaluation of the economists’ opinion that the US is experiencing a ‘new normal economy’
An economy is defined to have attained a ‘new normal’ if the consequences of a financial crisis have led to a situation that was previously considered abnormal. The impact of the global financial crisis on the US economy was extensive as evidenced by the decline in the level of consumption, investment, and employment. These events partly arose from the high rate of inflation and interest rates. To mitigate the country’s economy, the US government implemented different economic stimulus packages. Subsequently, most households and investors in the US expected the economic recovery to be immediate.
On the contrary, the economic recovery has been slow arising from different economic headwinds. The degree of investor and consumer confidence has not been fully restored. The country continues to experience a high rate of risk aversion hence limiting the level of investment. Moreover, the level of unemployment remains high. Thus, the rate of economic recovery is less robust as compared to what was projected. Consequently, the US economy is expected to experience a slower rate of economic growth in the next few years. It is projected that the rate of GDP growth in the US will be lower than 3%, which was experienced between the mid1990s and 2000s. This aspect shows that the recession has led to remarkable economic scars. Therefore, it suffices to argue that the US economy is currently characterized by a ‘new normal’ economic situation.
The consequences associated with the financial crisis can influence a country’s economic growth adversely. Thus, governments should consider the most appropriate policies to adopt to promote the attainment of the core macroeconomic goal, viz. full employment, stability, and growth. The management of financial crises should comprise the adoption of fiscal and monetary policies. The US government undertook different interventions to stimulate the country’s economic recovery. Nevertheless, the country is yet to recover fully from the effects of the recession. Thus, it has attained a ‘new normal’ economic situation. This aspect requires the consideration of other measures such as a reduction in government spending and tax rate.
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