Recession refers to short period associated with decline in economic activities such as decrease in stock market business, high unemployment rates, poor housing facilities, high cost of due to low purchasing power of the country’s currency and general failure in the financial institutions. Recession may vary in terms of magnitude and in terms of how long it may persist (Gaston, 1994). Most economists’ belief on this subject is that recession differs from depression only by the degree of their severity. The implication is that depression is more severe form of recession-though with similar consequences.
Usually, recession happens after the affected economy reaches the peak of their business cycle. What then follows is that there would be reduced income, decline in demand for goods and services, drastic fall in the employment level and excel demand generally described by Keynes as the demand pull inflation. The recession period ends when the country reaches slum.
The occurrence of this unpleasant economic times is blamed on leadership failure of Federal Reserve. Economic policies that would lead to rising interest rate, general increase in price level of goods and services, declining consumer confidence and low purchasing power of the currency are among those that cause recession.
Federal Reserve is the central bank of the United Stated of America whose existence dates back to 1913. The main purpose of the Federal Reserve was to provide a safe, flexible and stable monetary policies and creation of sound financial institutions. This explains why any occurrence of recession or depression in the US is blamed on this body.
Based on this therefore, the Federal Reserve plays a key role in policy formulation and implementation that helps the county to recover from the state of recession sooner. The effects of recession goes beyond the economic into political and social affairs of the state.
The main goal of macroeconomic policies is to maintain ideal and optimal business and economic atmosphere by striving to maintain stable price level, attempting to attain full employment and favorable balance of payment. These economic policies are however divided into two broad categories as; expansionary and contractionary economic policies.
Contractionary policies are used to reduce the rampant inflation rates. On the other hand, expansionary economic policies are used to increase the supply of money within the economy. The aim of these policies is to boost economic activities in order to recover the economy that could be languishing in the state of recession. For this reason, the Federal government can formulate and implement expansionary economic policies in the attempt to recover an economy from the recession period in the following ways.
The Federal government should consider reducing taxes. By doing this, it is expected that there will be increase in disposable income. Disposable income is the portion of one’s income that is left free for them to either spend or invest. Classical theory states that increase in disposable increases consumption level. Increased consumer spending is motivated by general tax reduction. Therefore, there will be a corresponding rise in aggregate demand in the economy (Slaughter, 1999). The tax multiplier principle postulates that average increase in demand for goods and services brings about increased rate of economic growth.
Since tax reduction is meant to boost consumer spending the government need to proceed with caution so that there will be no negative implication of the same. The problems of supply are likely to surface if care is not exercised by the authorities charged with the responsibility of policy implementation. For instance, a drop in prices of houses and credit shortage in the year 2008 in the United States was due ineffective implementation of tax reduction policy.
Secondly, the Federal government need to take deliberate actions to increase government spending. Government spending refers to investments of the government in public sector such as provision of quality health services, security and education just to name a few. This action of increased government spending should actually be implemented with caution. This is because the priority of spending so chosen by the government determines whether the problem will be solved or even grow worse. However, increased government spending on things such as training of expert manpower and provision of quality education have a tendency to improve labour supply.
When the government has decided to implement this policy, there is need to be cautious too. This is because excessive spending by the government may cause it to engage in heavy borrowing especially from the private sector (Slaughter, 1999). When this happens, there will be less capital base left for the private sector to invest or even finance their operational cost. When the economy reaches this level, the aggregate demand does not increase. This by implication is interpreted to mean that there will be not economic growth. As a word of caution therefor, the government need not to increase spending beyond the sustainable level which causes it to get into debts.
When prudent fiscal and monetary policies are put in place by the Federal government, expansionary economic policy will help to a large extent to offset increased saving by the private sector and this will inject more money in the circular floor. It is important for one to remember that saving is a withdrawal from the economy. This best described by the Ratchet effect that if more and more people in the economy engage in saving only but do not spend, this will make them even poorer due to decrease in aggregate demand for goods and services.
Various research has shown that effective expansionary policy implementation generally increase aggregate demand. Increased aggregate demand in an economy means that there is a sufficient number of consumers of all goods and services produced in the economy at a given time. As much as there are elements of caution to the extent to which expansionary policy need to considered efficient in trying to recover the economy from recession, the underlying principle is that this policy rises demand for goods and services in the economy.
Expansionary economic policy is also called easy money. This alternative name stems from the fact that this policy improves market interactions in terms of demand and supply. This by implication means that the value added on goods and services rapidly increases in the economy due to efficient trading in the market. According to (Kuhn, 1963) trading increases the value of goods and services. Therefore, we can logically conclude that a wise policy mix during recession increases the gross domestic product (GDP).
One of the major characteristics of recession periods is decrease in employment level. By implementing expansionary economic policy, there will be increase in both autonomous and induced investments. There will be need for both skilled and unskilled manpower depending on the nature of the sector of investment. These will create extra employment avenues for majority of the people in order to drive the economy further. Expansionary economic policy therefore have a tendency to push the economy towards full employment.
The reserve ratio refers to the amount of money required to be held by banks as reserve. Basically, it is kept at 10% of each deposit made by bank customers, though it is subject to change as directed by the Fed. The reserve ratio has an inverse relationship with the money multiplier. This means that these two economic variables move in the opposite direction at any given time.
During recession, where interest rates are high, the Fed acts by ordering a decreasing the money stock being held by the banks as reserve. As a result, there will be this induces expansion of credit and bank deposits resulting to fall in interest rates. Conversely, increasing this ratio decreases the amount of money stock available to give loans. This increases the cost of obtaining back credit due to increase interest rates.
Given the above conditions that invoke each decision, it should be logical to conclude that the Federal government will consider decrease in reserve ratio during the period of recession because it fits the economic assumptions of the expansionary monetary policy discussed above.
Discount rate refers to the minimum level of interest that the Fed set for leading money to other banks in the United States (Gaston, 1994). This interest rate is not fixed and can be altered depending on the prevailing economic needs. Increasing discount rate will restrict commercial banks from giving loans to businesses and individuals. The need to increase discount rate arises when the Fed rises that there is high inflation rates. This phenomenon arises due availability too much money in the circular floor.
High discount rate is meant to regulate the amount of money circulating in the economy by limiting commercial banks from loaning. Since interest rate are always higher than the discount rate, increasing discount rate means the cost of getting bank credit is also higher. Therefore this reduces borrowing.
On the other hand, when the government finds it necessary to increase the money supply in the economy, the discount rate need to be lowered (Slaughter, 1999). By doing this, more individuals, private firms and businesses will be motivated to obtain loan. This is because, when discount rate is low, it means that now the cost of credit is also reduced. When more money is injected into the economy, there will be increased investment as per the multiplier and accelerator principles.
Open market operations refer to the business and economic government activities of giving or taking government securities on the stock exchange. Government securities are financial instruments which can be used to directly influence the money supply in the economy. These are freely traded in the stock exchange and the government decides to what extent it will participate in the buying and selling of securities (Gaston, 1994).
During recession periods when there is limited amount of money in the economy, the government will increase its purchase of securities from brokers and individual investors. This action is meant to inject more money in the US financial system such as commercial banks. Availability of money in the banking sector will therefor induce investments leading to expansion of the economy. If follows that government participation in the stock market as a buyer of financial instruments such as bonds will lead to economic expansion.
On the other hand, if the government decides to sell securities, the aim is to reduce the liquidity level in the country. People who sell government securities are usually making investments which will yield a set return at their maturity time. Classical economic theory indicates that investments are withdrawals from the economy and this is the rationale of selling government securities as a way to reduce money in the economic circular flow (Gaston, 1994).
In conclusion, monetary and fiscal policy mix need to complement each other in the attempt to recover the economy faster during time of recession. Failure to observe efficient policy implementation has dangers of making a recession stay longer and this may result into a severe depression in the economy as it was the case in the US 1929 to 1933.
References
Abraham, F., Konings, J. and Vanormelingen, S. (2009), “The Effect of Globalization on Union Bargaining and Price-Cost Margins of Firms”, Review of World Economics, Vol. 145, pp.13.
Gaston, N. and Trefler, D. (1994), “Protection, Trade and Wages: Evidence from U.S. Manufacturing”, Industrial and Labor Relations Review
Kuhn, L. (1963). “Collective Bargaining and Inter- industry Wage Structure, International Evidence”, Economics,
Slaughter, M. (1999), “Globalization and Wages: A Tale of Two Perspectives”, World Economy,
