Monetary and Fiscal Policies
The 2007-2009 financial crises led to the Great Recession not only in the US but also the world over, leading to the European debt crisis and the Japanese exacerbation of economic stagnation Šehović (2015). The GDP in the US was 5.2 percent between the beginning of 2008 and the beginning of 2010. The US crisis peaked at the Lehman Brothers Investment Bank, which declared bankruptcy in 2008. This led to a mass loss of jobs and investments. Many central banks across the developed nations, including the European Central Bank, Bank of Japan, and the Federal Reserve Bank, opted to utilize unconventional monetary policies, especially Quantitative Easing (QE), in an attempt to stimulate their respective economies. The conventional monetary policy in the US proved to be ineffective. Though the QE works at the direct lowering of interest rates in the long term, it is ineffective in reviving an economy characterized by an excessively indebted private sector that is attempting to deleverage (Šehović, 2015). Hence, fiscal policy becomes an important stimulant for investment and spending in an economy that is over-indebted.
Monetary policy only indirectly stimulates aggregated demand (Dillard, 2018). The monetary policy does not increase the private sector’s net wealth; it only changes the composition of its assets. Fullwiler & Wray (2010) argue that when the private sector treasures are converted into deposits (this is what QE does), it does not need to induce more spending by the private sector. When the central bank buys securities to increase the private sector’s deposits, the wealth of the private sector remains constant. Even when the private sector does spending, it is done from existing wealth and not because there has been a wealth increase. Moreover, when the economy is already heavily indebted, a monetary policy that stimulates borrowing is not the best solution. In such a case, QE, which aims to stimulate spending and investment and lower interest, is also ineffective. The private sector ends up increasing its spending if there is an increase in its financial wealth, and this can only be possible through fiscal policy.
Dillard, D. (2018). The economics of John Maynard Keynes: The Theory of a Monetary Economy. Pickle Partners Publishing.
Fullwiler, S. T., & Wray, L. R. (2010). Quantitative Easing and Proposals for Reform of Monetary Policy Operations. Bard College Levy Economics Institute Working Paper, (645).
Šehović, D. (2015). The Impact of the Great Recession on Monetary and Fiscal Policy in Developed Market Economies. Business Systems Research Journal: International Journal of the Society for Advancing Business & Information Technology (BIT), 6(1), 56-71.
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Discussion Prompt: Monetary and Fiscal Policies
Which was more effective in getting us out of the Great Recession of 2007-8, monetary or fiscal policy?
Use the case on the American Recovery and Reinvestment Act (2.3) of our Taking Sides text listed in the Session 2 Readings, as well as your research on the Federal Reserve, to support your response to this question.
Bonello, F., & Lobo, I. (2015). Taking sides: Clashing views on economic issues (16th ed.).
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