Introduction
Monetary policy is the endeavor by the federal or state government to control the amount of money circulating within an economy. These control measures are undertaken to cub the instances of inflations or to control the interest rates to sustainable levels. Monetary policies can either be expansionary or contractionary. Expansionary monetary policies are meant to expand the supply of money to the economy thereby boosting the economic activities (Afonso, 2012). Expansionary monetary policies also lead to a reduction in average interest rates. Contractionary monetary policies, on the other hand, are macro-economic tools used by the federal or the state government to slow down the rate of money supply to the economy. It is the function of the central bank to regulate these policies to ensure that the inflation and the interest rates are at sustainable levels. These policies aimed at reducing or expanding the money supply to an economy is also called Fiscal Policies (Afonso, 2012).
Recession is a significant decline in economic activities of a given country lasting for several months. The Great Recession occurred between the periods of December 2007 and July 2008 in the United States. This was followed by a global recession which occurred in 2009. During any recession, the federal government or the state government undertake policies which are aimed at solving the situation. Improper use fiscal policies can lead to Double Deep Recession. A double deep recession is when two recessions occur within a relatively short period of time. This happens when an economy deep into a recession and quickly recovers, only to deep into another recession leading to a Double-Deep. One can detect a recession by looking at changes in certain economic factors such as the Gross Domestic Product (GDP), employment rates and retail sales. The second deep usually means that the economy has recovered from the previous recession too fast. This can be as a result of the government stimulating the supply of money to the economy, expansionary policies. Expansionary Policies can lead to an inflation that pushes the economy into another recession (DeLong, 2012). It is therefore imperative that the expansionary policies to cub an economic depression be conducted in a sensitive way to prevent any instances of a Double-Deep. This paper seeks to explain the rationale by which the Expansionary Fiscal Policies were used to correct the Great Depression.
The Great Depression
The Great Recession occurred between the periods of December 2007 and July 2008. This started in the early 2000s. There was a boom in the real estate industry. As a result many people invested in the sector. Financial sector started to market the mortgage-based security to the public. Most of the investors dropped other investment and joined the real estate sector. The Real Estate Investment Trust sold out more share to the public who were selling out their shares from other industries to invest in the real estate sector. In 2007, there was a bubble burst in the real estate sector. The entire sector collapsed with the real property values dropping drastically (Robbins, 2011). Mortgage-backed securities dropped drastically. The entire public lost in the stock market as the as the value of their stock dropped drastically. This did not just affect the public but also banks and big investment firms. Lehman Brothers which was the fourth biggest investment bank in the United States by then went bankrupt. Many firms collapsed leading to high levels of unemployment. Being that the United States was conducting business with other countries, this recession started to spread to other countries. The European countries were influenced most making them to go into a depression as well. Due to the Great Depression, the United States lost more than 7.5 million jobs hence the highest unemployment rate ever. The American household also lost a net worth of 16 trillion Dollars. This was as a result of a plunge I the stock market ((Robbins, 2011).
Expansionary Monetary Policies
Expansionary Monetary policy is a strategy to expand the money supply to an economy. This is often done to fight a recession. It involves injecting more money to the economy. This can be done by reducing the interest rates. Low interest rate will increase investment and stimulate demands. When interest rates are low, investors will tend to borrow more money to expand their business. They may build new factory or open a new store. By spending the money they borrow and hiring new workers, they stimulate the economy and lower unemployment (Afonso, 2012). Expansionary policy is not only one side of the coin. Too much growth can lead to inflation, in which case also makes us to want to do the opposite, contract the money supply and slow the growth. In the United Sates, the Federal Reserve System is responsible for these decisions. The Federal Reserve System has several tools that change the money supply. These tools include; federal fund rates, reserve requirement and open market operations.
Federal Fund Rates is the interest rates banks charge each other for overnight loans to meet their reserve requirements. For example, if ABC Bank takes 100 million Dollars in deposit and pays out 95 million Dollars to other costumers, only 5 million dollars will remain at the bank for daily transactions. If many depositors want their money back at the same time, ABC Bank might run shot of money causing a bank failure. Bank failures can heart other banks and possibly the entire economy. Therefore, the Federal Reserve Bank which is the United States’ central banking authority has to set the minimum amount of money which every bank has to hold to guard against the bank failure; this is called the reserve requirement. In many cases, the reserve requirement is always roughly 10% of the deposit (DeLong, 2012). Banks often hold this money at the Federal Reserve Bank where they are called federal funds. If a bank as too little in reserve, it borrows more money overnight from either the Federal Reserve Bank or other banks. What the Feds charge for overnight loans, is what are known as federal fund rates.
The Federal Reserve Bank uses its discount rates to influence the federal fund rates. If the Federal Reserve Bank feels that the economy needs stimulating, it may announce a lower federal fund rates. They can then lower the discount rate. This will force other banks to lower their effective federal funds rate to meet the target. This target has varied over years with the highest record of 20% in 1980s. During the great recession of 2008-2009, the Federal Reserve Bank maintained the federal funds rate to as low as 0% to 0.25% (Almunia, 2010). With very low federal funds rate, the banks were able to commercial banks were able to acquire more money from the Federal Reserve Bank. This enabled the commercial banks to lend out money to investors. With access to more funds, investors were able build new factory or open a new store. By spending the money they borrow and hiring new workers, they stimulated the economy and lowered the rate of unemployment.
The Reserve requirement is the minimum amount of money every commercial bank must hold at any given period of time. The reserve requirement is set by the Federal Reserve Bank. At the same time, the Federal Reserve Bank keeps the Reserve Requirements for all the depository institutions. To influence an economy, the Federal Reserve Bank may set a higher reserve requirement of a lower reserve requirement. During the Great Recession of 2008-2009, the Federal Reserve Bank reduced the reserve requirement by 210 million US Dollar, (Almunia, 2010). By reducing the reserve requirement, the banks have a lot of money to lend out. With higher lending, the investors get access to more funds. Investors were able build new factory or open a new store. By spending the money they borrow and hiring new workers, they stimulated the economy and lowered the rate of unemployment.
Open Market Operations is the buying and selling of the government bonds in an open market. The selling and buying of the government bonds is controlled by the Federal Reserve Bank. When the Federal Reserve Bank buys out the government bonds from the public, there will be an increase in the supply of money to the public. With such increase, more people will be able to invest as thereby stimulating the economy and lowering the rate of inflation. On the other hand, the Federal Reserve Bank may decide to sell out the government bonds to the public. By buying the bonds, there will be less money in the hands of the public hence lowering expenditures to and reducing employments (Rothschild, 2013). This tool can be used to reduce instances of inflation in an economy.
During the Great Depression, the Federal Open Market Committee resolved that the Federal Reserve Bank should buy the government bonds. By so doing, those who had the bonds received money from the Federal Reserve Bank in exchange for the bond. More money was pumped to the public (Rothschild, 2013). Investor would now use these cash to expand their businesses or create new businesses. This stimulated the economy and reduced the instances of unemployment as many people could now get jobs from the new expansions and new and new industries.
Conclusion
The aggressive expansionary fiscal policies which were employed by the Federal Reserve Bank as well as other central banks from other countries are credited for preventing even a greater depression. These policies were however criticized by other scholars as they also had a negative impact to the economy. The impacts included higher inflation rates and lower interest rates.
References
Afonso, A., & Sousa, R. M. (2012). The macroeconomic effects of fiscal policy. Applied Economics, 44(34), 4439-4454.
DeLong, J. B., Summers, L. H., Feldstein, M., & Ramey, V. A. (2012). Fiscal policy in a depressed economy [with comments and discussion]. Brookings Papers on Economic Activity, 233-297.
Robbins, L. (2011). The great depression. Transaction Publishers.
Rothschild, D. (2013). America’s Great Depression.
Almunia, M., Benetrix, A., Eichengreen, B., O’Rourke, K. H., & Rua, G. (2010). From great depression to great credit crisis: similarities, differences and lessons. Economic policy, 25(62), 219-265.
