The decade from 2000 to 2009 was marked by market volatility, earning it the moniker "lost decade." In the early 2000s, the United States experienced huge spectacular run-ups that caused the market sector to collapse. High leverage and speculative bubbles characterized the decade. Particularly, the United States was beset with financial scandals that grew hard to stomach. Terrorist assaults like that of September 2001 devastated the US economy. Other important issues that this decade faced included the subprime mortgage crisis and the bank liquidity crisis, which culminated in the 2007-2009 Great Recession. The government was forced to step in several times in order to initiate legislation and monetary policies that were directed to address the financial problem and correct the market instabilities. Among these include the signing of law such as tax cuts and extension of unemployment insurance in response to the recession. Perhaps, 2000-2009 ended with many financial lessons that proved to be significant to markets in the entire world.
Key words: Great Recession, Monetary Policy, Lost Decade, Inflation, Subprime Mortgages, Unemployment, Interest Rates.
2000 -2010 Monetary Policy
When the millennium set in, the country was recovering from a period of recession. The GDP by December 2000 was 10.47 trillion, and it rose exponentially until 2007 to a value of 14.69 trillion. However, when the Great Recession started in 2007, the value of GDP declined in 2008 and 2009. In 2008, the GDP level was 14.55 trillion, and that of 2009 was 14.57 trillion. The 2006 subprime mortgage crisis and severity of the recession period is attributed to the drop in the GDP. The recession period made the market to suffer vital financial setbacks. The rate of interest rates rose and discouraged borrowing, and unemployment level increased. The GDP stabilized in 2010 after the great recession, and it grew to 15.23 trillion. The lost decade also saw an increase in the interest rates, inflation level, and unemployment. According to Bureau of Labor Statistics, in 2001-2002, the rate of inflation decreased by 1.2 %. However, the other years were described by fluctuations in the interest and inflation rate which caused volatility in the market. The increase in the interest rates and inflation saw a decrease in foreign investment.
The Great Recession
A healthy economy involves alternating periods of contraction and expansion. However, if the contracting period is more prolonged for approximately over six months, it hurts the economy, and it is termed to be an economic recession. The period of Great Recession was characterized by imbalances and declines in the world economic markets which started December 2007 and extended to early 2010. The timing and the scale of the Great Recession did vary from one nation to another with more impacts evident in the US. There were declines in the economic activities which spread globally across the world economies. Evidence could be seen in the reduction of the GDP, industrial production, employment rate and overall sales reduction. The Great Recession caused the financial meltdown in the financial sector which spread at an alarming rate and affected the corners of the world. The International Monetary Fund did indicate the recession to have been the worst since the Second World War. It is linked to the American subprime mortgage crisis and the overall global crisis that hit the world in 2007 to 2009. It led to the collapse of the world financial sector and had other detrimental effects that significantly damaged the economy. The Great Recession is termed to be harmful and caused economic downturns in the world economic markets. This paper will evaluate the issues that surrounded the Great Recession including, the causes, the consequences and the policy measures that were set to address the economic problem.
Causes of the Great Recession
Some factors led to the Great Recession which included high levels of public debts, bank panic, and a bank run, the fall in the stock market and frizzing of the money market. The financial crisis that took its roots to almost every part of the world resulted from interest rates, global imbalances, financial system regulations and risks. The causes are discussed below.
Housing Crunch
The rate of economic growth and the consumer spending largely determined the housing market in the US and the entire world. There was an increasingly faster rise in the prices of the houses, more than the income of the consumers. The increase in the prices of these houses resulted in overvalued assets. There were adverse effects on the spending of the consumers due to the increase in the value of the mortgage. Subprime mortgages and low-interest rates led to crunch
Subprime Mortgages
There were subprime mortgage bursts which stemmed from the unregulated mortgage industry. Mortgages were sold to people, and no considerations were done to determine the payment ability of the individuals buying the house. It is estimated that the valued the US subprime mortgages in March 2007 stood at 1.3 trillion USD. The US subprime mortgage impact bubbled contributing to the great recession. There were massive foreclosures where, the brokers and the institutions that were not under cover of Community Reinvestment Act severely suffered. This indirectly led to slower economic growth rates influencing investments and consumer spending.
Low-Interest Rates
The monetary authorities of the US adjusted the levels of integrated rates to unprecedented values and thus resulting in a consumption boom of the debt finance. This further boosted the bubbling in the housing sector. The integrated rates had for a long time stayed low, directly leading to the great recession. Failure of the monetary authorities to address the problem of the interest rates led to overvaluation of assets quickly contributing to the subprime mortgages,
Credit Crunch
Sudden shortages in funds due to the subprime mortgages caused a decline in the available loans. The risky mortgage loans made numerous commercial and investment banks to encounter massive losses. They run out of funds and the credit crunch created by them reluctance in lending of money to any individual. Consequently, shortages of money in the money market were deemed devastating to the economy. In the finance sector, the shortages in the liquidity led to difficulties in financial borrowing as it became more expensive to access credit. The credit crunch thus influenced the economic investments and consumer spending.
National Debt and Budget Deficit
Exorbitant national debts and national deficits saw the great recession take its roots to deeper levels. In America for instance, the national debts stood at 65% of the overall gross domestic product of 2007. The situation worsened when the liabilities of pension were included. With the massive reported levels of national deficit, there was a smaller room for the fiscal policy expansionary effect to take action. The problem arose from the idea that demographics did work against the stability of the fiscal policy coupled with the worsening of the economic cycles. The national deficit had many effects. Investments were hampered as there were challenges encountered in attracting capital inflow. The investors from Asia who had known of the deficit that hit the US slowed down their capital flows into the American economy. Thus, devaluation of the dollar was the consequence which is also termed as the causes of the great recession. The reduction in the capital inflow created critical imbalances between the domestic production and consumption. The decline in the domestic production and consumption constrained the growth of the economy and thus the causing the great recession.
Devaluation of Dollar
The basic economic theory holds that a reduction in the exchange rates assists in the increase in the values of products exported. A rise in the value of exports stimulates the export sector growth. However, the depreciation of the dollar which caused its devaluation highly led to cost-push inflation in the economy. This type of inflation made the products to be very expensive to be affordability of the consumers given their income levels. Thus, there was a decline in standards of living of the people as the consumers were faced with low expenditure powers deteriorating the economy and hence the great recession. The American economic market thus became to be less competitive in comparison to its trading partners.
Consequences of Great Recession
Unemployment
As noted before, the great recession caused economic crisis across the global markets. In the nations that are middle incomes had severe impacts. The downturn in the economic growth rates saw many countries suffer I n their financial sector. In the US, great effects were seen on its labor market where, the rate of unemployment stubbornly stuck at high levels. The rate of unemployment in America rose from 9.5% to 10.1% in June 2009 and October 2009. The rates were indeed devastating. Imbalances were evident between the supply and the demand of workers and high rates of layoffs characterized the labor market.
Shrink of Industrial Profit Margins
Many industrial companies encountered shrinking profit margins, particularly to the Indian companies that had deals with the US. The reduction in the profit levels resulted from the declined consumer expenditure, devaluation of the dollar and the money market crisis. The primary contractions experienced during the Great Recession as a result of the global crisis in the national deficit negatively impacted on the profit margins of the companies. Other sectors of the economy such as agriculture also faced the predicament of negative profits.
Effects on the Financial Market
The global financial markets were badly hit. The market share value declined with currencies weakening against the dollar. Bank runs and bank panics led the economy into a state of disorganization with severe cash crunches. The financial market saw shortages in the liquidity of the market. The reduction in foreign domestic investment (FDI) also affected the financial market. The reduced investment level led to reduced capital inflow and thus reduced the supply of money. The financial assets in the market were hugely affected
Other consequences were:
Contracted GDP levels leading to national deficits
High inflation rates that led to increased prices of the products and reduced demand
Reduced personal income levels of individuals
Reduced concentration of wealth
Banking crisis that stemmed from shadow banking, bank panics, and bank runs.
Recovery Policy Measures
EGTRRA and ARRA Policy Measures
Fundamental changes in fiscal policy were done in the 1990s. Congressional Budget Office (CBO) in January 1990 noted that the budget deficit in the nation would rise to $100 billion in that fiscal year. The situation was projected that it would worsen in the years that followed and this proved to be true. In 1999 the debt was $125.6 billion and rose to $236.2 billion in 2009. This called for actions to stimulate the economy and thus tax cuts, increase in government expenditure to spur economic growth were formulated. President George W. Bush on June 7, 2001, signed “Economic Growth and Tax Relief Reconciliation Act (EGTRRA)” to stimulate the economy. In the long run, the EGTRRA saved taxpayers $1.35 trillion over a 10-year period. On the other side of the coin, the government revenue reduced in the long run due to the tax cut and this also hurt the economy. The “American Recovery and Reinvestment Act” of 2009 (ARRA) was an economic stimulus package which was signed into law by President Obama. This was to revive the nation in the wake of the economic downturn. It outlined the expansion of unemployment benefits, tax relief, and social welfare provisions. Domestic spending on health care, education and in the energy sector became a priority economic recovery measures.
Fiscal and Monetary Policies
There were both fiscal and monetary responses that were directed to end the great recession. The monetary and the fiscal policies were majorly initiated by banks together with the monetary and the fiscal authorities. The monetary actions included the lowering of the interest rates and stimulation of the economy through the open market operation. The fiscal stimulus included a reduction in the tax rates and increased in the government expenditure. The severity of the market caused the fiscal and monetary policies to be accompanied by other economic stimulus such as central bank expansion of balance sheets. In boosting the volume of exports, and prevention of the excessive inflation, nations resolved into buying the foreign currencies to avoid devaluation of the currencies. The cost of borrowing was reduced, and there was a reduction in the required commercial bank reserves that they have to keep with the central bank. The increased government spending directly led to increased demand levels of products. With reduced taxes, companies were able to raise their profit levels and thus to cause growth in the economy. All these expansionary effects had a sole objective of bringing the great recession to an end, and they successively managed to end the recession.
Loans Backed by Commercial Asset Papers
With the significant withdrawals from the money market funds, financial risks were created. Thus a policy was derived where individuals would lend cash to the money market to be used in addressing the financial crisis. The money lend to the institutions was exchanged by short-term securities. These securities were commercial papers that were known as asset-backed- commercial paper (ABCP). The commercial papers were also directed at eliminating bank runs which had severely hit many economies. The short-term financial aid is given to the institutions enhancing liquidity in the system off the market. ABCP was also used by banks in obtaining funds from the Federal Reserve Bank and the Treasury. ABCP was used as collateral assets.
Legislation
A number of legislations were set by governments. In the US for instance, President Bush and the secretary to Treasury, Henry Paulson made a legislative proposition that the government would buy $700 billion of the “trouble mortgage-related assets” from the financial institutions. The idea had intentions of improving the level of confidence in the mortgage market. The law was signed and the plan proceeded. Stimulus plans to recover the US economy were declared by President Obama. The plan had hopes of creating more than 3.6 million employments in two years. The economic recovery plan cost was about $825 million. There were major strategic reforms in the health and investment sector. Measures to encourage more investment were set which attracted much PDI.
Conclusion
In the current era of globalization, the economy of every nation is influenced by fluctuations in the global market economies. Therefore, the great recession resulted in many impacts to the world including decreased growth rates, shortages of money, fall in demand and high rate of unemployment. The great depression turned down the economic growth prospects of every country. The significant negative impacts of the great recession led to the formulation of strategies which will stimulate the economies, create stability and mare the economies competitive.
