Academic journal article International Journal of Business

Financial Crisis and Economic Downturn

Academic journal article International Journal of Business

Financial Crisis and Economic Downturn

Article excerpt

I. INTRODUCTION

In the current economic downturn the Federal Reserve and federal government have chosen different methods to stimulate the economy. The main factor is the choice of financing each have following to implement their stimulus program. The Federal Reserve had opted to use quantitative easing, in increasing money the Federal Reserve hope to ease credit and investments by the commercial banks therefore improving the flow of money in the economy. The federal government has opted to use US Treasuries in paying for huge fiscal stimulus programs to stimulate the economy. Both are feasible for the objective each is trying to pursue; however both have long term disadvantages on the economy.

Certainly the argument on using counter cyclical monetary policy to reduce price volatility and macroeconomic risks at the banks is relevant to the whole economy not least because of the credit market. As mentioned by Mishkin (2009), there is a misconception in the general view that monetary policy have failed with the reduction in valuation and macroeconomic risks. Another key success of the aggressive monetary easing policy adopted by the Federal Reserve is the lower interest rates on US Treasuries and hence a reduction in the credit spreads. However in providing $6.4trillion dollars in liquidity and capital to the banking system, the Federal Reserve chose not to rely on the controversial method of raising capital via the US Treasury issuing debt on behalf of the Federal Reserve but instead to use quantitative easing. According to Taylor (2009) contrary to the generally held view the Federal Reserve didn't significantly increase it's holding in US Treasuries as part of the executing of quantitative easing.

Underlining any arguments on fiscal stimulus policy is the increase in the supply of debt. The problem is that any stimulus policy is going to be very expensive and there is no guarantee of its success. And whether or not it is successful is irrelevant when considered against the huge tax burden of an increase in the interest payment on the debt in the long run. Therein lay the key issue which bought this famous quote from Keynes (1923): "The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again" However the analysis of the US economy seems to point to the requirement of fiscal stimulus policy to stimulate the economy and with the federal government already having committed a staggering $4.56trillion and respectively to recapitalize or save a number of big corporations and stimulate the economy.

In researching and analyzing the factors influencing the supply of US Treasuries during the current recession, it is essential to note the depth of the recession. According to Feldstein (2009) at the heart of the current recession lies the huge erosion of householders' wealth to the extent of $10 trillion mainly due to the underpricing of risk and excessive leverage, which resulted in the repricing of risk causing a fall in the price of shares and houses. This resulted in householders becoming more risk averse to expenditure which leads to a reduction in production causing either a hike in unemployment or a reduction in income; hence leading to a downwards spiralling economy. The evident based on the data from the Federal Reserve and Bureau of Economic Analysis seems to be suggesting that this is the worst recession since the 1930s and as of 31 July 2009 it is certainly the longest since the 1930s according to the National Bureau of Economic Research.

The analysis into the wide use of both policies during the current recession is compelling, since quarter 3 2008 both the federal government and Federal Reserve have fiercely implemented their own countercyclical policies. The massive increase in debt and monetary base is evident of these increasingly costly countercyclical policies with a total of $10. …

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