Question

In your analysis of the macroeconomic data, you will notice that the U.S. economy passed through a major recession. Based on research, discuss the underlying causes of the recession. Identify monetary and fiscal policies implemented by the Federal Reserve and the government to deal with the recession.

Answer 1

The main causes of the recession include international trade imbalances, high levels of household debt and real estate bubbles. Once the recession began, various responses were attempted with different degrees of success. These included fiscal policies of governments, monetary policies of central banks, measures designed to help indebted consumers refinance their mortgage debt; and inconsistent approaches used by nations to bail out troubled banking industries and private bond holders, assuming private debt burdens or socialising losses. The asset prices (i.e housing and commercial property) declined, the liabilities owed to global investors remained at full price, generating questions regarding the solvency of the customers, governments and banking systems. This debt overhang led to slow consumption and slow economic growth. The fall in asset prices caused the equivalent of a bank run on the U.S., which includes investment banks and other non-depository financial entities. Struggling banks in the U.S. and Europe cut back lending causing a credit crunch. Consumers and some governments were no longer able to borrow and spend at pre-crisis levels. Businesses also cut back their investments and demand faltered and reduced their work forces. Higher unemployment due to the recession made it more difficult for consumers and countries to honour their obligations.

The governement and Federal Reserve adopted some important Fiscal and Monetary policies to deal with recession. Through the fiscal policy, the governement included tax cuts to bolster household incomes, new infrastucture investments, and financial assistance to state and local governments.

In the monetary policy, the federal fund rate was cut down rapidly. A downward pressure was put on the long-term rates. Because it is these longer term rates that have the largest effects on spending behaviour.