Discuss the Demand-side Policies and the Great Recession of 2008?
Introduction
Recession in economics refers to a business cycle where contraction is taking place and there is
gradual slowdown in most economic activities in a country. All the mac?roeconomic indicators
register decrease in economic growth such as a decrease in GDP, business profits, investment
spending and an increase in the rate of unemployment and bankruptcies. Recessions are triggered
mostly by financial crisis, extreme supply shocks or external trade shocks that result in massive
decrease in spending that creates an adverse or critical demand shock in the country.
The major aim of demand side policies is to increase the general aggregate demand. The policies
contribute positively to economic growth especially during recession period.
PL AS
Demand-side Policies and the Great Recession of 2008 2
P2
P1
AD2
AD
Y1 Y2 Y Real GDP
The monetary policies are the tools that most governments utilize to influence the economic
activities in a country. To increase the rate of Aggregate demand, the government through its
central bank can reduce the rate of interests to make borrowing affordable to the public hence
encourage investment and consumer spending. The low interest rates act as an incentive to
encourage more investment in the economy and also may lead to reduced mortgage interest rates
payments hence allow more disposable incomes to households (ETSU, n,d).
Devaluation for countries that have a fixed rate system helps in restoring the country’s
competitiveness due to reduced cost of exports and increased costs of imports. A decrease in
exchange rates results in cheaper exports and more expensive imports
Fiscal policies are developed and implemented by the government to increase demand by
reducing and cutting down taxes to encourage extra spending. Reduced taxes make some
commodities or services to be more affordable to the public hence it encourages consumer
spending. Lower taxes increase the consumer’s disposable income which results in more
spending. Higher levels of expenditures leads to expansion and consequently more employment.
Fiscal and monetary policies have succeeded and also contributed to the creation of other
economic conditions that have resulted in negative growth of the economy. For example, the
reduction of the interest rates may not always encourage spending and investments. The ordinary
Demand-side Policies and the Great Recession of 2008 3
citizens in an average economy face many challenges like accumulated debts, mortgage
payments and high living costs hence the savings due to reduced rates may not have a very big
impact in their daily consumption patterns. In 2009, the UK rates were reduced to 0.5% but still
it was not enough to spur economic growth as majority of banks were still unwilling due to
liquidity shortages. It may be cheap for the banks to lend but very difficult to create some credit.
The monetary policy in the UK was actually ineffective in improving the economy.
Monetary policies adopted by the US during the 2001, 9/11 disaster distorted some economics
activities as a result of the reduced interest rates. As a result of the low interest rates that were
adopted by the US government most families, individuals and companies were encouraged to
apply for ambitious loans and also mortgages hence it evolved into the famous US housing
bubble. These resulted in destabilize economic growth patterns in later years.
To finance the expansionary fiscal policy in 2008, the US government had to borrow from the
private sector in order to finance the fiscal stimulus packages that were aimed at boosting the
economy. Heavy borrowing from the private sector can lead to increases in interest rates as the
demand for loans increases (Sullivan & Sheffrin, 2003).
The US government utilized the non-discretionary fiscal policies known as the automatic
stabilizers to increase the aggregate demand during the 2008-09 recessions. The government
utilized the progressive income tax and also the welfare system to generate more aggregate
demand during the recession which led to changes in spending and reduced taxes. During the
2008-09 recessions, the deficit stimulus that occurred as a result of the automatic stabilizers were
actually larger than the discretionary fiscal policy.
Demand-side Policies and the Great Recession of 2008 4
Finally to conclude, the fiscal and monetary measures adopted by a government to control
recession largely depend on the state of the economy or the level of recession that a country has
been reduced to, the implementation and the success of the policies. The US government through
the Federal Open market Committee or FOMC meets regularly after seven weeks to deliberate
and make policy changes that affect country’s economy. FOMC utilizes the monetary and fiscal
policies to control the economy. Most of the efforts of the committee have succeeded but some
may take a considerable period of time before their effects are felt. It’s very hard to match a
governments discretionary fiscal policy together with its business cycle. The Kennedy initial tax
cut of the year 1964 that was expansionary and later the 1974 contractionary Ford tax were
implemented when actually the policy that was required was contra cyclical. Hence the
government only applies discretionary fiscal policies during severe recessions as in the case of
the years 1981 and 1982 and also the 2008-09. The federal government had to issue large
financial stimulus packages and tax cuts to create the much needed deficits to stabilize the
economy.
Demand-side Policies and the Great Recession of 2008 5
References
ETSU (n, d) Fiscal Vs Monetary Policy
Sullivan, A. & Sheffrin, S.M. (2003) Economics: Principles in action. Upper Saddle River, New
Jersey 07458: Pearson Prentice Hall. p. 111.
