Question

Analyze Financial crisis 2009 in US with IS-LM model in short run and long run, if there were no stabilization policies implemented.

Answer 1

Crisis is a very important concept in discussions of economics science, political and strategic and has many examples. In the economic field, it involves rapid and dramatic rise of prices, production expanded reducing, sharp rise of unemployment, a sharp reduction in income, sharp reduction in the value of securities and etc. In the political field, it contains social
revolts increasing, developed gap between government and citizens and in the field of strategic, crisis has examples such as military and coercive regime dealing with social groups or neighbouring countries and other countries. So, when the word of "crisis" is used, it means that the security threat is in the last process its existence. Structural change is considered as one of the main consequences of the crisis. After
emergence of the crisis, if there dos not be any measure to its roots and to make decisions about structural changes, crisis re-emergence should be expected. Necessity of structural changes is to prevent similar crises repetition or other crises. Crisis lead to new theories and also these theories create new structures. So, theories are result of crises and on the other hand, they are facing to the theoretical and practical challenges and crises. It is clear that theoretical challenges affects to new structures and newer structures occur. In 1776, Adam Smith (1723-1790) by publishing his great economics book, Wealth of Nations, established Modern Economics. But from creation of capitalism economic system Recessions and Depressions and economic downturns have been experienced. Karl Marks (1818-1883), great German economist and sociologist believed in that recessions and economic crises are the nature of the capitalism economic system. Economists as Schumpeter
(Schumpeter, 1939) are arguing that business cycles can be predicted, but some others like (Mankiw, 2007) and Romer (Romer, 2006) are saying no. There is no doubt, however, that the Great Depression was one of the world's largest downturns in economic history. It inspired John Maynard Keynes to develop his revolutionary theory. He argued that economy can be recovered by boosting consumer spending. The Great Depression was overcome by several Keynes inspired economic programs and stimulation between 1933 and 1935.Several recessions and economic downturns had occurred since then. There is little doubt that, the relevance of Keynsian economics is being questioned during every economic downturn in the previous century. A result of that is the rather influential works of authors such as Fausto Vicarelly and Paul Krugman. In 2007 new recessions started. Many economists are comparing recession of 2007-2009 with the Great Depression. Many governments have already adopted fiscal stimulus plans and lowered interest rates as close to
zero (Funa, University of Ljubljana, 2009). Economic fluctuations are referring to the business cycle, which occur over longer periods and cover periods of economic expansion and economic stagnation. Usually, these fluctuations are measured by the growth of real GDP (gross domestic product). As the term implies, a business cycle is a period of up and down motion in aggregate measures of current economic output and income. Figure 1 illustrates a hypothetical business cycle. When most businesses are operating at capacity level, the real GNP is growing rapidly, and the unemployment is low, boom condition exists. Boom conditions result in a high level of economic activity. As aggregate business conditions slow, the economy begins the contraction phase of a business cycle. The aim of this research paper is to attempt to understand the 'Trilema' which has confounded the economists on how to handle the three parameters like output, interest rates and currency effectively, to achieve the optimum level for a given economy, and even to drive an economy from recession to recovery. The authors used the US economic recession (2007-2009) event as a starting point and looked at policy interventions, both fiscal and monetary. They envisaged as to how the three chosen parameters played out over time, and what economic models can explain the basis of both the policy intervention and recovery. Our exploratory work is to understand the economic policy parameters that are critical to manage; yet which has been complicated by the US's most open economy, to which the basic ISLM models could not support. The team finally found that the Mundell-Fleming model does make sense for open economy like US. The researchers analysed the data from US economy to see if the model is able to justify the data coming out from US from 2006-2016, when many policy interventions were taking place. The team focussed on the causes of this recession; because it was important to understand the variables underneath which caused the crisis in the first place. Another factor explored was the causes of the crisis, which to illustrate how money market was stretched by excess credit creation and excessive risk taking by the commercial banks in the post repeal of Glass-Steagall's Act in 1999. It also led to the phenomenal growth in the derivatives market and rapid integration of global capital markets across the world. This research paper also goes back to the fundamental question, as to if the monetary policy is more effective or fiscal policy is more effective? Or both need to be played in recovery. Was there even a role of fiscal policy and in what form was it deployed in US economic recovery? Finally the authors confirm that forex market equilibrium co-exist together with goods and money market equilibrium for open economies as that of US. It believed that currency markets are very important and important policy decisions should look at the long term impact on the currency stability; in the lens of competiveness of economy in the global market place.