Principles of Macroeconomics. The financial crises of 2008
Principles of Macroeconomics
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The financial crises of 2008 caused a rethinking on macroeconomic policies that were best in avoiding or preventing future cases of similar economic occurrences. In order to fix the economic problem in the financial crisis of 2008, identifying the economic problems that resulted to the financial in the US economy would be critical. The reason why there is needs to establish the cause of the financial crisis is to create a basis for making ultimately good decisions on the economic policies to be implemented. The solution to the problem however lies in the application of various policies including fiscal policies and monetary policies. The monetary policies applied before the crisis are said to have lead to the financial crisis and therefore its application in future could be doomed in the future economic policy application. The fiscal policies were therefore introduced for implementation in the attempt to solve the financial crisis in the United States economy.
Probably, poor monetary policies that had been implemented to boost the US economy had a great effect on the causes of the 2008 financial crisis. Financial crises are mainly caused by frequent application of monetary policies leading to an economic boom as a resulting economic bust that is inevitable. The US financial crisis of 2008 happened in the same way whereby the application of monetary policies aiming to catalyze the US economic growth in the country caused a housing boom as well as bust (Stark, 2009). The economic boom and bust in turn resulted to the financial chaos in the US as well as in some other countries. Monetary excess was the main cause of the financial crises that left many macroeconomists wondering on the best policies to apply in order to restore the economy to its normal position.
The effect of monetary excess could be analyzed in terms of the loose fitting monetary policy that was applied. In this case, the effect came from the Fed reserve policies and decisions. This case was from the Feds effect on interest rates in the economy starting from the year 2000 to 2006. In this case, the effect of the monetary policy was on the falling of interest rates below any time in the US history (Stark, 2009). The implication of the resulting case of interest rates is that the monetary policy could be made with ease without considering the long-term effects of the policy. Since 1970s, the Fed policies had been consistent with hardly great deviation apart from during this time when the effect of the monetary policy resulted to very low interest rates in the US economy (Stark, 2009).
The decision made to lower interest rates in the economy was purposeful but the deviation from the normal adjustments by Fed created a major historical problem in the US economy due to the witnessed financial crisis. The decisions were made that interest rates were to be very low at a given period, which would then rise gradually to a given point and within a given period (Stark, 2009). The low interest rates had an economic effect in that borrowing became easy to people and businesses. This aspect resulted to increased investments, high productivity, and increased aggregate demand in the US economy. On another aspect, the financial crisis of 2008 resulted from the impact of the United States subprime mortgage crisis. The subprime crisis involved events as well as conditions that contributed to the financial crisis of 2008 but also led to an economic recession in the same year. The crisis was characterized by an increased subprime mortgages, their delinquencies, some foreclosure, as well as decline in securities in the mortgage market.
The crisis in the mortgage industry led to the collapsing of many and major financial organizations by September 2008. At the same time, there was a significant disruption of to businesses as well as consumers in terms of credits flow to such businesses and consumers in the US economy. One can hardly blame financial institutions or the Fed entirely for the monetary policies implemented since the financial crisis was caused by a combination of factors (Fried, 2012). Several individuals and commentators placed blame on regulators, government policies on housing, consumers, as well as the financial institutions for the subprime mortgage crisis.
The key issue in this case is that house sale prices in the US reached their peak in 2006 from which they began to fall. The declining house sale prices resulted to a system of difficulties in refinancing. This problem had to be handled through increasing interest rates or resetting them in a way that led to increased monthly payments for house rents (Levy, 2002). The result of this was the soaring of many mortgage delinquencies with securities backed up with mortgages and subprime mortgages being increasingly held by globally operating financial firms, who eventually lost their values.
The government policies were on the other hand being over regulated with some case of deregulation and failed regulations. An example of the government contribution to the crisis was its regulation and policy to increase home ownership. At the same time, the government decreased its regulations on financial institutions in various steps were taken to decrease regulation in the banking sector that also contributed to the financial crisis of 2008 (Levy, 2002). The government and Fed had to realize what led to the financial crisis to implement other policies to curb the crisis while focusing on the short-run effects and the long-run impact of any policy implemented.
The solution to the monetary policies that had resulted to a boom and increased inflation was curbed by absorbing the excessive money supply in the US economy. This was done by increasing the rate of interest and cutting down on government spending. The reduction of interest rates resulted to an economic situation whereby people preferred saving to consumption thereby reducing the aggregate demand in the economy. On the other hand, government reduced spending but traded its bonds and securities for money to reduce the economic aggregate demand (Fried, 2012). This police was however, effective in the short run given that in the long term, the economy would lead to a decreased GDP. This aspect of the monetary policy was therefore least applicable in solving the financial crisis.
In terms of the fiscal policies, regulations in various sectors of the US economy meant that the financial crisis could be adjusted according to the policy but hardly allowing market forces to take control in restoring the economy from the financial crisis. Fiscal policies were also initiated to get rid of the subprime mortgage crisis that was largely contributing to the financial crisis (Maximus, 2008). The crisis had led to increased government deficit but through decreased regulation on the financial institutions especially in the banking sector. Reduced regulations provided the sector with freedom to make adjustments in the mortgage sector providing room for easy adjustment in interest rates. Through tax rebate as part of the fiscal policy, investment in housing could be restructured as well as development of the foreign sector (Maximus, 2008). The changes caused by the fiscal policies also promoted encouragement of the foreign sector in which case those foreigners who had withdrawn from the economy were now reinvesting back enhancing the reduction of unemployment in the US economy hence curbing the problem in both short term and in the long term.
References
Fried, J. (2012). Who Really Drove the Economy Into the Ditch? New York, NY: Algora Publishing .
Levy, K. T. (2002). Subprime Markets, the Role of GSEs and Risk-Based Pricing. Washington, DC: Urban Institute.
Maximus, F. (2008, September 25). A solution to our financial crisis. Retrieved March 23, 2013, from fabiusmaximus.com: http://fabiusmaximus.com/2008/09/25/a-solution/
Stark, J. (2009, June 8). The economic crisis and the response of fiscal and monetary policy. Retrieved March 23, 2013, from ecb.int: http://www.ecb.int/press/key/date/2009/html/sp090608.en.html
