Recession - Explain the origins of the current crisis and the measures taken by the US authorities to resolve it.

University Degree Business and Administrative studies

Tracy IFY business 3

Recssion

“The world economy is in the grip of the most severe recession since 1930s. Banks are ailing and manufacturing industry is collapsing. Consumers have lost much of their wealth and unemployment is climbing”

Explain the origins of the current crisis and the measures taken by the US authorities to resolve it.

A recession is a situation of decreasing real GDP, falling incomes and rising unemployment for two consecutive quarters. Nowadays the world is suffering the worst recession, which means the economy has negative growth，banks are suffering and manufacturing industry is falling. There are many symptoms show the economy of the world is in a situation of recession. For example the house prices falling, a lot of banks are collapsing and many businesses are declining. The value of money that people have is depreciated so that individuals lose their wealth, then there is less money running in the economy which leads to less production and high unemployment, therefore the GDP is falling. In this essay I would like to analyse what caused the current recession and what are the current policies of the US government to solve the crisis.

From last year with some symptoms of the economic recession occurred, the world economy hold the toughest recession. There are many reasons which have lead to recession. The first cause is the credit crunch, which is the main reason leading to the recession of the US. The credit crunch refers to a sudden shortage of funds for lending, leading to a result of decline in loans available. And the sub-prime mortgage, which means mortgage companies give inappropriate mortgage to people who want to buy houses who have low incomes and poor credit. It is the fuse that causes a credit crunch. Before the recession the house market of the US was booming. During the recession the house prices have “fallen by a staggering 18% over the past year” (Economist, 2008). With the house prices falling and the increased interest rates result in an expensive mortgage repayment, so the customers can not pay the money back. Then mortgage companies take their houses but can not regain their loan, therefore leading to the companies lose a lot of money, finally leading a credit crunch which means banks have no money to lend or afraid to lend, so that there are less loans available.

As we know, because the credit crunch reduced a supply of cash, many small and medium-sized businesses can not get a mortgage. Therefore, they do not have enough cash flow to run the business. As a result, many businesses go bankrupt, so many people lose their jobs, and then they do not have enough money to afford a house or a car etc. Hence, this shifts the aggregate demand leftwards and causes a declining in manufacturing industry. As diagram 1 shows the output falls from Y1 to Y2.

Because the decreased aggregate demand, there is a movement in ...

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Because the decreased aggregate demand, there is a movement in supply. We can see from diagram 1, the equilibrium falls from E to F. With the decreased aggregate demand, many manufactories lose sales. For example “General Motors said its sales fell 45% compared with March 2008, Ford's sales dropped by 41% and Chrysler's by 39%.”(BBC, 2009) Generally, when the firms lose profit during the recession, they would no longer use as many workers as they used to use; then, there is more unemployment. As more people are becoming unemployed, there are less people with purchasing. This is a vicious circle of the economy. The unemployment rate in the US is up to 8.1%, it can measure as a high unemployment rate which leads to a falling GDP in the US. The table below is the GDP of the US from 2006- 2008. Since 2006 the GDP of the US is decreasing year by year; it means the economy of the US reached a recession.

Table 1 Source：Trading economics-online

The credit crunch has also affected the banking system. The Lehman Brothers which was the fourth biggest investment bank went bankrupt as a result of the credit crunch. Specifically, the credit crunch affects the stocks and the bank loses profit, and then goes to a serious financial crisis. With the credit crunch many businesses can not get a loan, it directly affect the productivity of firms. If firms do not have capital, they can not make more goods available, so this shifts the aggregate supply leftwards. It means firms lose output, therefore lose profit. (As diagram 2)

The effects that the financial crisis has had are clearly visible. The US has a high unemployment and a low GDP growth, which is decline economy. Of course, as there’s a recession of economy, the US government has taken economic measures to offset this crisis. The US government followed Keynes theory, which recommends governmental intervention; then, the US government decided to “slash interest rates to 1 %”( BBC, 2008). The US government was trying to reduce the interest rates to increase money supply and encourage consumption. Therefore increase the aggregate demand and also encourage firms’ investments during the recession, in order to keep high GDP growth reduce the percentage of unemployment. And then The US government capitalized banks and firms, it increased the aggregate supply. Consequently, these shift the aggregate demand and supply rightwards. As diagram 3 shows, the increased aggregate demand, the equilibrium raise from B to C and the output increased as well. And the more aggregate demand is; the more supply to be. So the aggregate supply goes up with the aggregate demand increases. And then the equilibrium falls from C to D, but the output is increasing. (As diagram 3)

The recession has clearly been a top priority for America’s new president, Barrack Obama. He has intensified efforts to stimulate fiscal policy through tax cuts to increase the aggregate demand. He has increased government spending to revive the economy, introduced tax cuts for low-income families, and corporate tax cuts to increase employment opportunities. He follows Keynesians focus on the demand side effects of changes in taxation and government spending to increase aggregate demand. Increasing the government expenditure is good for all the people not just those who can afford services.

In conclusion, I think more government expenditure will cause deficit. Maybe the recession will continue, or in the future will cause inflation. However, the policies of increased money supply can provide an incentive for people to consume and shift the aggregate demand, promoting economic growth. In my opinion after a few years, the economy of the US will bounce back.

Reference

BBC (2008), US interest rates slashed to 1%

Available: 02/04/2009

BBC (2009), US car maker sales down for March

Available: 01/04/2009

Economist, (2008), Markets and data, Daily chart, House price through the floor, Available: 01/04/2009

Trading economics, Global economics research, United States GDP Growth Rate

Available: 01/04/2009