Despite suffering one of its worst economic downturns in its history, the U.S. economy has made remarkable progress since 2009. Beginning in 2007, the global financial crisis turned dramatically from the collapsing housing market in the US into far-reaching recession by the end of 2007. The economic fortunes of various countries were thrust into uncertainty by what has come to be known as the “Great Recession.” The “Great Recession” is defined as the ensuing economic contraction that was experienced in the U.S. beginning from the end of 2007 (Taylor 64). During a recession, there is often a persistent reduction in the level of GDP for period of six months or more. This period is defined more by reduced rate of growth that leads to a contraction in real income, employment, and industrial production. In most cases, the government intervenes to alter aggregate demand either through fiscal or monetary policies.
Fiscal and Monetary Policies
The demand-side policies involve the monetary and fiscal policies whose focus is to change aggregate demand (AD) in the process of achieving macroeconomic objectives. The fiscal policy involves the use of taxation and government spending to influence a nation’s economy. Katz (22) states that changes in government spending have a direct impact on AD. During a recession, expanding government expenditure and decreasing income taxes stimulates AD. An expansionary government spending move seeks to stimulate AD during this time when there is an economic slowdown. An expansionary fiscal policy would, therefore, be used to close a recessionary gap by increasing the AD. On the other hand, a contractionary fiscal policy helps close out the inflationary gap in an economy. Often accentuated by decreased government spending and an increase in income taxes, the contractionary fiscal policy reduces AD by creating a budget surplus.
The monetary policy involves those actions by the Federal Reserve directed towards expanding or contracting the money supply so as to affect the cost of credit. It has a direct effect on the short-term interest rates. As such, an expansionary monetary policy seeks to increase the availability of credit and stimulate private spending in the process of stimulating demand growth. Some of the tools used to this effect include OMO (open market operations), discount rates, and the reserve ratio.
The Use of Demand Side Policies During the Great Recession of 2008
With the economic downturn in 2008, the U.S. economy experienced a falling GDP at the rate of 6% per annum (Blinder, Alan and Zandi 2). The economy was also losing approximately 750,000 jobs on a monthly basis. The unprecedented response through fiscal and monetary policies was responsible for the economic recovery. For example, the Fed began by lowering interest rates in 2008 and initiating a zero-interest-rate policy with the target of providing liquidity to financial markets and institutions. It also brought down the long-term interest rates after buying treasury bonds and the mortgage-backed securities. Perhaps, the most outstanding fiscal policy by the government in 2009 was the tax rebate checks that were directed towards the middle income and lower income households after the American Recovery and Reinvestment Act (ARRA) was passed in 2009. Its major aim was to create new jobs and save the existing ones while also promoting economic growth. The government used close to $1 trillion in tax credits to these households with the hope of increasing their spending, promoting growth and encouraging job creation. The stimulus ended the Great Recession and spurred economic recovery.
The Great Recession of 2008 was also handled using the monetary policies to offset the rapid economic decline. Having lowered the interest rates to 0%, the Fed turned to massive quantitative easing by purchasing assets such as corporate bonds to stimulate a greater money supply in the economy. Specifically, the Fed purchased the Fannie Mae and Freddie Mac mortgage-reliant securities as well as the Treasury bonds (Blinder, Alan and Zandi 3). By the end of 2010, the financial system had begun to recover at almost a 3% rate and job growth had resumed although at a slower pace. The impact of the fiscal policies could be felt by the end of 2010 since they had managed to raise the real GDP to 3.4% and held off the rate of unemployment at about 1.5% points lower from the run-away unemployment rate of 9.5% at the beginning of 2008 (Nakamura, Emi and Steinsson 23). In such a short period, the economy had managed to add over 2.5 million jobs. To date, the unemployment rate has fallen to 4.9% to indicate the enormous growth of the economy since 2008.
Demand-side policies have had a huge impact on the journey of U.S. economic recovery especially after the Great Recession of 2008. The immediate fiscal and monetary policies used in 2008 provided a strong foundation for economic recovery by promoting consumer spending, improving employment and increasing industrial production. It is estimated that without the intervention of the fiscal and monetary policies in 2008 and 2009, the US GDP and employment growth would have been less by 12% and 8.5 million jobs respectively by 2010 (Stiglitz 44). This proves that the demand side policies have played a huge role in restoring economic growth and reducing unemployment since they were implemented. This is proven by the stable US economy today that promotes the creation of over 150,000 jobs today on a monthly basis.
Blinder, Alan S., and Mark M. Zandi. How the great recession was brought to an end. Moody’s Economy. com, 2010.
Katz, Lawrence. “Long-term unemployment in the Great Recession.” Members-only Library (2014).
Nakamura, Emi, and Jón Steinsson. “Assessing the effects of monetary and fiscal policy.” NBER Reporter 1 (2015): 22-25.
Stiglitz, Joseph E. “How to Restore Equitable and Sustainable Economic Growth in the United States.” The American Economic Review 106.5 (2016): 43-47.
Taylor, John B. “The role of policy in the Great Recession and the Weak Recovery.” The American Economic Review 104.5 (2014): 61-66.