Economic Crisis Policies in the US

Economic Crisis Policies

US current economic crisis is considered to be started from real estate sector. The real sector started to decline in 2006 and it accelerated in 2007 and 2008. Housing prices have fallen from the peak from about 25% so far. The decline in prices left homeowners with no option and they were unable to refinance their mortgages and causes default of mortgages. This default of mortgages and loans swallowed the banks and financial markets such as falling of Lehman’s brothers and other Banks and blow to rest of economy happened as the whole economy was relying on banks and ultimately it slows down investment in the country and capital flows to other parts of the world like China and India. Bank losses cause reduction of bank capital which in turn requires capital reduction thus saving bank from lending. It is estimated that every $100 loss and reduction of bank capital would cause $1trillion reduction in bank lending. (ISR international socialist review, 2009)

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Critical Analysis of the Causes of Current Economic Crisis

The current depression is said to be biggest since the great depression of 1930’s.There are many causes of current economic crisis. Some of them are discussed below.

At the macroeconomic level we have seen that consumption has increased over last two decades, aggregate household consumption represents more than 70% of gross domestic product. Consumption increases due to relaxed credit policy for real estate sector which ultimately results in low saving, which puts strain on governments’ revenues because of increased investments and results in budget deficits. (Journal of accountancy, 2009)

Another major cause of downturn of U.S. economy is decline of rate of profit in U.S. economy as a whole. From 1950 to 1970 the rate of profit decreases about 50% and around 22 to 12% in onward period. This decline in profits is due to decline in general trend during this period.

Marxist theory while explaining this decline says that this decline further prove to be a double edged sword and cause higher unemployment and soared inflation and also cause lower real wages which paralyze the growth process and cement higher unemployment rate. Moreover, the lower rates of profit in U.S. push the capitalist to bring the rate of profits back to track, while doing so they followed the policy of higher inflation by increasing the prices at a faster rate, which reduced real wages. The more and more U.S. companies followed this practice of reducing wages which caused unemployment.

Another widespread strategy that is followed by U.S. companies is reduction in health insurance benefits and retirement pensions. Article in the New York time magazine entitled “The end of pensions” also highlighted this. Some of the capitalist are following the policy of downsizing and 10 to 20% employees are forced to leave their jobs.

US companies also follow the strategy of bankruptcy as a way to cut benefits and wages. Companies declare bankruptcy which allows them to resettle their debts and declare their union contracts null and void. This strategy was first introduced by steel industry and then followed by airline industry in recent years. Glaring example of this is Delphi; Delphi declared bankruptcy in October 2006 that reduced wages by approximately two thirds and benefits accordingly. Surprisingly, The Delphi chief executive has also publicly urged other automobile companies to adopt the same strategy.

The United States senate issued the Levin — Coburn Report, which found that a crisis was due to high risk, undisclosed conflicts of interest, and complex financial products, failure of regulators, the credit rating agencies and the market itself to exercise itself in excesses of Wall Street. Some of the analyst is of the view that credit rating agencies and investors have failed to accurately judge the risk associated with mortgage related financial products and government is responsible in the sense that it did not exercise its regulatory practices to address the 21st century financial markets. (Eyes on wall street, 2011)

Some of the critics are of the view that U.S. war on terror has also sapped U.S. economic strength. President Bush inherited surplus budget but long war on terror especially in Afghanistan cost U.S. billion of dollars and has caused all time high budget deficit.

There are some other famous analysts like James Livingston who are of the view that consumer behavior is very important in determining the economic growth and he says that over saving caused the present economic crisis. He is of the view that consumer culture is very important for the success of the capitalism. He argued that ideological view of the economy is dangerous, creating confusion for the state that how should it respond on economic crisis that are hurting the prospects of U.S. economy.

To know more about economic crisis I would also like to refer Report of the financial crisis Inquiry Commission. Report refers the recklessness of the financial industry and absolute failures of policy makers and regulators that collapsed the American Economy in 2008. Capitalist were saving their own interests, focusing on high profits, reducing workers, and hence increasing unemployment. Moreover, policy makers were not able to judge the economic crisis and were failed to adopt appropriate policies. After all these recommendations, a renowned economist Nouriel Roubini calls out for more financial equality and said that current economic systems have failed to deliver its social responsibility.

Some of the reports on U.S. economic crisis suggested that political rivalries and delayed economic decisions were also reasons behind economic crisis that U.S. has suffered. It was evident from the fact that last minute resolve of heated debate in congress on bailout package spread gloominess among the investors. There were also other serious differences between the republicans and democrats over economic decision making.

Solutions Adopted by American Government

There is famous bailout package of $800 billion, announced by Obama government to rescue the American economy. Some of the economists like Jeffrey Sachs defended this bailout and considered it as unavoidable. They favored the car companies and said that in competencies on the part of car companies is right reason to let them fail. However, those who were against this bailout package like Huge Hewitt regarded this bailout as unacceptable. They were of the view that this bailout passed unnecessary burden on tax payers and favored free market forces. They supported on to let the entrepreneur rise from the ashes. The response of Federal Reserve was much expected and came forward to rescue its economy.

US monetary authorities reduced their official interest rates by the end of 2008. Federal Reserve immediately reduced federal funds target rate at nearly zero percent but they were positive.

Chairman of Federal Reserve Ben Bernake termed it as zero lower bound. This policy was followed by two accompanied developments.

1- First step which Federal Reserve did was reorganizing itself into new role of financial institution that is by changing the way in which it provides credit to financial system and terms of the credit. So, it became the direct lender to wide variety of financial institutions. It took active position in providing credit and managing liquidity risks.

2- Second role which, Federal Reserve played was that it kept the total size of balance sheet static for more than a year which helped in pushing the to zero.

Federal Reserve also responded to the crisis through its open market operations. Its open market operations are discussed below.

Federal Reserve had main policy tools prior to emergency in the U.S. treasury. Only banks used to maintain reserve accounts at the Fed. Only U.S. banks could avail the opportunity of U.S. discount window. The Federal Reserve held U.S. treasury securities balance sheet. Federal Reserve utilizes its open market operations in the U.S. treasury market to achieve the target of U.S. federal funds. In August 2007, the Fed opted different role. It started to advance own credit against its own collateral and not only to U.S. commercial banks against U.S. government bonds. In 2008, it swamps the U.S. financial system with its own zero interest rate and with risk free liquidity.

In December 2007, it developed two new lending facilities, a Term Auction Facility. Under this operation it gave loans to federal funds for one month through regularly scheduled auctions. Moreover, they controlled the system of foreign exchange swap lines with the help of foreign central banks. By this it provided partner central banks accessibility to the dollars. Thus banks going through financial crisis got an access to loans. Later on, Fed regulated the portfolio of U.S. treasury securities to establish its reliance on lending.

To control the acute instability that hovered over the U.S. financial system markets in March 2008, it developed a program under which it started to lend primary dealers, U.S. treasury securities against collaterals (including private label mortgage backed securities). It helped in seizing 30 billion dollars in non-performing mortgage related credit securities and provided primary dealers and investment banks to avail the facility of its discount window.

The Fed Reserve took measures to bring U.S. money market back to its operations by assuming that U.S. financial system had enough liquidity to expand the market operations. Fed Reserve accepted the less credit worthy securities as collateral and held safe U.S. treasuries to keep the money supply constant. These were later termed as “toxic waste removal” policies.

Fed Reserve introduces another set of program by taking over multinational insurance company American International Group (AIG) on September 2008. This program was implemented through option of purchasing asset backed commercial paper from money market mutual funds. This policy was termed as Quantitative easing by Bernake.


First the U.S. economic crisis was only of real estate and later on it developed into global financial crisis. If it is to be judged that Fed Reserve response was appropriate or not then in my it was not a success like condition in the interbank market only worsened and Fed swamped the U.S. banking system with unprecedented quantities of reserves during 2008. Banks considered them idle funds at the Fed rather than utilizing them as constructively. Even, network of U.S. interest bearing came to stagnate.

However, Fed Reserve was not a complete failure and policies of Fed Reserve were success in some ways. Its intervention in U.S. financial system mitigates the crisis otherwise crisis would have wreaked havoc. For example Fed reserve have given U.S. financial system a risk free state security and another phenomenal role was Fed’s success in providing the U.S. banking system a concrete monetary base by which it could safely handle the crisis.

However, some of the analysts are of the view that Fed Reserve role was manipulated due to political powers of some powerful industrialists in capitalist society. For example, it took the toxic wastes from the AIG and Bear Stearns on its books for years and its lending terms assumed that they were paid back on its own political terms and not according to law terms. (Rude, 2009)

Fiscal policy tools are always exercised according to the structure of the market and it sometimes under performs so it has to be exercised carefully. We will see in the following paragraphs that how U.S. government applied its fiscal policy tools to avert the economic crisis.

Government enhanced spending for boosting GDP growth to mitigate the increased unemployment rate to targeted level. These spending were injected into the market but much of the costs were lost due to administrative expenses and others were lost due to transit costs. Moreover, tax cuts and certain investment subsidies did not reduce unemployment and it did not reach the unemployed people.

Normally, during recession, government increased its spending, tax cuts, and increase in unemployed welfare benefits and other transfers are provided to poor people and same policies were adopted by former President Bush and current President Barrack Obama.

First policy response was from the government of President Bush in 2008. First large purchase from the U.S. government at that time by buying a large number of from the balance sheets of sick banks it also include private banks. At that time congress provided the Fed Reserve 700 billion dollars for executing this policy under the program named troubled asset relief program. (TARP)

The TARP injected massive funds into General Motors and Citi group and also performed the virtual nationalization of insurance icon AIG. Moreover it also purchases real goods and services from the private firms and provide them real time assistance.

Second part of fiscal stabilization plan was followed under Obama administration named American Recovery and Reinvestment Act in February 2009 (ARRA). It demarked an additional 787 billion dollars that included 288 billion dollars in tax cuts and benefits to individual and firms. It also allocates 275 billion dollars for contracts, grants and loans and 224 billion dollars for entitlements.

However, TARP and ARRA alone constituted approximately 10% of GDP but its effects for GDP growth and reducing unemployment were of small size. (R.Tcherneva, 2011)

Obama while taking the office promised to create 3 to 4 million jobs and introduced ARRA it did not fulfill the intended purpose but according to without that stimulus package the unemployment rate would have reached the rate of 9%.

Fiscal policy followed were targeting growth rate, which were thought to create jobs automatically, but it did not achieve the desired effect.

The Chairman of Fed Reserve Bernake supported the reduction of budget deficit particularly by reforming the social security and Medicare entitlement programs. During his address on April 7, 2010 he favored that the U.S. must soon develop a credible plan to address the pending funding crisis and the reduction in interest rates.


ISR international socialist review. (2009, april). Retrieved from The U.S. economic crisis:causes and solutions: http://www.isreview..shtml

Journal of accountancy. (2009, october). Retrieved from The U.S. economic crisis: root causes and road to recovery: www.journalofaccountancy.com/Issues/2009/Oct/20091781

Eyes on wall street. (2011, april). Retrieved from Levin coburn investigates casues of financial crisis: http://www.eyesonwallstreet.com/2011/04/articles/financial-crisis/levincoburn-report-investigates-causes-of-the-financial-crisis/

Rude, C. (2009). World Economic Crisis and Fed Reserve Response to it. Studies in Political Economy.

Tcherneva, R.P. (2011). Fiscal policy effectiveness: Lessons from the Great Recession.

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