Issues of Economic Crisis
The recent recession and the financial crisis have paved the way to uncommon and hostile actions by policymakers of fiscal and monetary policies. Secular stagnation is for ensuring achievement of full employment, for lowering and stabilizing inflation rate, and for maintaining financial stability. Current macroeconomics failed to analyze financial crisis because of its incapability of envisaging current issues prevailing in the economy. Analysis of these topics is essential because they help in determining and then solving the problems of economy by taking adequate measures in a timely manner.
There are several causes of recent Great recession. Major causes include lower demand from household, creation of too much money from banks that is used for pushing up prices of houses, which ultimately paved the way to creation of debt burden, and housing bubble bursts in which increased availability of mortgage loans and lower interest rates gives opportunity to people to extend credit to the borrowers that are not maintaining good financial record. In order to cope with the situation of Great recession, recession fighting fiscal and monetary policies plays various roles. Monetary policy makers have, however, adopted quantitative easing, and fiscal policymakers have focused on reducing taxes and increasing government spending. Expansionary monetary and fiscal policies have helped in shaping recovery expectations. However, forecasters have increased their expectations regarding GDP and inflation for ensuring effective implementation of policies. Specifically, expansionary monetary policy have exerted its impact on forecasts of inflation, and monetary policy have impacted economic growth expectations. These policies have, however, played an important role in keeping away deflationary pressures and in increasing economic activity during global recession. Monetary and fiscal policies have responded effectively to the Great recession. Monetary policy helped in designing exchange rate related policy for influencing volatility and level of exchange rate. Further, quasi debt management policy was designed for lowering the borrowing cost and increasing price of assets. However, it also assisted in designing credit policy in order to bring necessary improvements in financing conditions in particular debt markets of private sector. It also played significant role in bank reserves policy for increasing aggregate demand and lending. Furthermore, the fiscal stimulus that is implemented during great recession of year 2008-09 comprises of increase in government spending and reduction in tax. They are, however, designed in order to stabilize inflation and economic activity. This can be justified with the fact that increase in government spending exerts its direct impact on the economy by increasing demand for goods and services. However, this paves the way to increase in employment and income, and this increase exert indirect influence by increasing private consumption because of increase in purchasing power of firms and household. It can be said that monetary and fiscal policies have exerted immediate influence on expectations. However, economic theory allocates a main function in the mechanism of policy transmission. This can be analyzed with an example of increasing optimism or positive thinking regarding economic growth of future cab help in increasing spending of firms and household. Further, high expectations of inflation can be helpful in decreasing real borrowing cost for firms and household, and help in increasing economic activity. Thus, monetary and fiscal policies have played important role in increasing financial stability by acting as stabilizers, and also helped in changing economic environment by increasing positive expectations about future.
However, secular stagnation hypothesis emphasizes on the fact that income is concentrated in the hands of only a few people such as in hands of the rich. Such people have low propensities to consume, which decreases economic activity. This has paved the way to increased saving and lowering of real interest rate, which has created difficulty for central banks as they are trying to increase demand by increasing nominal interest rate instead of making it zero. According to Ben Bernanke, secular stagnation is about inadequate aggregate demand, it is not about inappropriate aggregate supply. Though output of economy has capability of growing, yet inadequate consumption and investment prevent the economy to achieve its target. Secular stagnation, however, ultimately paves the way to the reduction of aggregate supply because of reduction in productive capacity of the economy due to lower capital formation and long term unemployment in the economy. Fed is in a position of reducing nominal rates below zero, and also it cannot decrease interest rate below −2%. However, considering that in case of secular stagnation, the equilibrium real interest rate of economy is below −2%, and is expected that it will stay there. Fed, however, does not have the power to achieve full employment until it increases its inflation target, and accepts appearance of financial bubbles for enhancing business as well as consumer spending. It means that there are three economic goals that are meant to be achieved, and these goals are low inflation, full employment, and financial stability. But, they are difficult to attain in the economy in which secular stagnation is prevailing.
Current macroeconomics is not successful in analyzing financial crisis because of inability of envisaging most important issues of economy, macroeconomic modeling, and economic forecasting. This is because economists and policy makers associated with macroeconomics rely solely on just one method or technique, as a result of which they fail to predict and analyze properly. Furthermore, there is academic orthodoxy, which is not allowing policymakers to move beyond consumers, producers, and financial institutions. There is so much reliance on mathematical models. Additionally, there is lack of understanding due to inadequate allocation of research and development efforts in economics, specifically in macroeconomics. Economists focus too much on rational behavior and ignore irrational behavior as a result of which they fail to achieve their targets and objectives. Economists, however, underestimate the risks associated with financial instruments because of which analysis of financial crisis become difficult for them.
There is a need that economists should use several theoretical perspectives and empirical researches in order to become capable of attaining their target. They should use comparative approaches so that they can compare results in order to obtain accurate results at low cost. Instead of focusing on just one tool, they should consider variety of options so that instead of doing experiments in the economy, exact solutions can be applied for solving the problem in an effectual manner. They should not ignore irrational behavior, they should collect evidence and analyze irrational behaviors so that effectual treatment of economy can be ensured particularly during period of recession. Economists and policymakers should think beyond traditional macroeconomic tools in order to ease the situation during recession, because economy requires effective and creative approaches for solving problems that prevails during recession. This helps in ensuring smooth functioning in the economy.
