Question

The introduction to this chapter described the behavior of consumer spending at the end of 2008. Explain this phenomenon in terms of the analysis presented in this chapter.

Answer 1

The real estate bubble burst and the subsequent financial crisis in the 2008, caused a significant decrease in the household consumption in the economy. It caused the reduction in the aggregate demand. Due to decrease in the aggregate demand, the firms reduced the production activities and there was a rise in the unemployment rate that further contributed to the decrease in the aggregate demand. It caused the price level to come down and inflation level decreased. These developments created a chain of negative economic activities and consumer spending showed a decreasing trend. It caused the economy to enter into the recession phase.
To help the economy recover from the recession, the federal government applied expansionary fiscal policy that involved increased level of government spending and decrease in taxes. It stimulated the aggregate demand and firms were encouraged to produce more. It also created new jobs. Hence, a cycle of positive economic activities took place and consumer spending slowly increased. Expansionary monetary policy in the form of lower interest rate and increase in money supply also helped to encourage the household spending as well as the investment spending. It pulled the economy out of the recession and recovery phase started.