the Great Recession

Paper instructions:
During the Great Recession, like any other economic downturns, as unemployment rises, aggregate income declines causing a major decline in tax collections. On the other hand, with the rise in unemployment, spending on safety net programs rise. So, there are not too many good options available to resort the health of the national economy.  It will be very difficult to defend cuts in the federal government programs and especially the programs geared to sustain the minimum of the standard of living for the recent “poor.” So, government needs to increase its borrowing. Deficit spending refers to government spending exceeding what it brings in federal income and corporate taxes during a certain period. Deficit spending hence increases government debt. Most economists accept that deficit spending is desirable and necessary as part of countercyclical fiscal policy. In such a case, government increases its borrowing and hence its deficit to compensate for the shortfall in aggregate demand. This is derived from Keynesian economics, and has been the mainstream economics view.  Following John Maynard Keynes, many economists recommend deficit spending to moderate or end a recession, especially a severe one. When the economy has high unemployment, an increase in government purchases creates a market for business output, creating income and encouraging increases in consumer spending, which creates further increases in the demand for business output. (This is the multiplier effect).  This raises the real gross domestic product (GDP) and the level of employment and lowers the unemployment rate. Government borrowing under such circumstances increases the demand for borrowing and thus pushes interest rates up. Rising interest rates can “crowd out” (discourage) fixed private investment spending, canceling out some of the demand stimulus arising from the deficit

Write an essay analyzing the advantages and disadvantages of deficit spending and the effects of federal government borrowing on the economy i.e., the “crowding out” effect.

Complete this essay in a Microsoft Word document, APA formatted and then submits it to “TurnItIn” for plagiarism review. Please note that a minimum of 700 words for your essay is required.

Your paper should be structured as follows

1.       Cover page with a running head
2.       Introduction: What is deficit spending and how does it work.
2.1.        Advantages
2.2.        Disadvantages
3.       Crowding-out Effect
4.       Conclusions: Do you believe that deficit spending helps or hinders short-term and long-term economic growth?
5.       References

THE GREAT RECESSION

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INSTITUTION

LECTURER

DATE

The American economy has faced five states of depression often characterised by low Gross Domestic Production, unemployment, high rate of inflation. The nation suffered a massive recession which is also known as the Great recession from December 2007-October 2009. The country estimated an approximate figure of 8.4 million people who lacked jobs at the beginning of the recession (Gustman, 2011). The recession affected the whole world with factors such as an increase in oil prices and food prices making the situation even worse. The great recession lead to great drop in international trade, lack of employment, and low pricing on products. Great financial losses in 2008 lead to the building up of the crisis with companies such as Bear Stearns and Lehman Brothers failing to invest in a secure way. Both United States and the United Kingdom governments developed policies that would assist in preventing another recession as well as assist the nation to crawl out from the previous recession.

The monetary policy is a tool the government uses to reduce and prevent high rates of inflation, lack of employment, and increase the GDP. Purpose of the monetary policies is to control the amount of money circulating in a nation through implementation of various aspects such as Open Market Operations, controlling the interest rates in loans, adjusting the reserve requirements.

Open Market Operation

During recession the Federal Reserve System may decide to buy treasury bonds with the aim of increasing the reserves in banks. High reserve levels in a bank allow increase in the amount of lending as well as lower interest rate on loans. In 2008 the US Federal Reserve System bought treasury bonds and loaned several corporations such as AIG insurance company to prevent them from collapsing. Funding the banks was aimed at increasing the level of lending so as to allow investors to easily invest hence increasing the GDP and create employment. 2012 statistics show a 2.5 increase in the GDP while the rate of employment has also increased as a result of this policy.

Discount on interest rates

The central bank may decide to increase or reduce its interest rates as a way of controlling the level at which commercial banks lend out money (Laurens, 1998). Through increasing discount rates the Central Bank hopes to increase rate of investment since loans are accessible to investors. On the other hand the Bank may decide to increase its rates on interest as a way to reduce the rate of inflation in the country. This policy was implemented in 2008 where the Federal Reserve System lowered its interest rates allowing investors and companies that were almost collapsing to borrow money. Through this the level of population unemployed reduced which in return increased the Gross Domestic Product of the country.

Fiscal policies are measures drawn to reduce the rate of unemployment by increasing the spending level of the country. This policy is also used to reduce the rate of inflation in the nation.

Lowering the level of taxes

Lowering taxes on raw materials aids in increasing level of production in the country hence improving the GDP ratios and also increases number of jobs in a country since production is high and labour is required. Lowering taxes also increases consumer spending allowing the flow of currency in the nation. In 2008 the United States government decided to cut its taxes to fifteen percent therefore increasing consumption rate. The results of this measure increased aggregate demand and with the high level of production and employment GDP rose by 1.6 percent in year 2011.

Delay Increase on tax rates

Contrary to the above measure the government may also decide to increase taxes on some products as a way of reducing overflow of money within the country so as to reduce the rate of inflation (Laurens, 1998). This is mainly used on long term spending commitments that would lead to the increase in level of inflation. This policy was implemented in 2008 and as a result the levels of borrowing reduced hence preventing inflation and prevent deterioration of the GDP.

These policies allowed the nation to crawl out of recession hence reducing high rate of unemployment, prevent inflation as well as increase country’s production.

References

Gustman, A. L., & Steimeier, T. L. (2011). How did the recession of 2007-2009 affect the wealth and retirement of the near retirement age population in the Health and Retirement study? Cambridge, Mass: National Bureau of Economic Research.

Laurens, B., & Piedra, E. D. (1998). Coordination of monetary and fiscal policies. Washington, D.C: International monetary fund, Monetary and Exchange Affairs Dept.