Assignment Instructions
The 2008 financial crisis has caused macroeconomists to rethink monetary and fiscal policies. Economists, financial experts, and government policy makers are victims of what former Fed chairman Alan Greenspan called a “once in a century credit tsunami”—in other words, nobody saw it coming. Because you are now the expert in macroeconomics, your friends keep asking you your thoughts on what caused the financial crisis and whether the United States is going in the right or wrong direction with its current policies.
Focus specifically on the following:
- Monetary policy
- What monetary policies do you think caused the 2008 financial crisis?
- What were the effects of the policies implemented in reaction to the 2008 financial crisis?
- Do you think the solutions worked in the short term? In the long term?
- Fiscal policies
- What fiscal policies do you think caused the 2008 financial crisis?
- What were the effects of the fiscal policies implemented in reaction to the 2008 financial crisis?
- Do you think the solutions worked in the short term? In the long term?
Make sure you include the following concepts in your analysis:
- Interest rates
- GSAs
- The financial services industries (CDOs, CMOs, the stock market, credit
flows, money markets, etc.) - Tax rebates
- Aggregate demand
- Stimulus
- TARP
- Government debt and deficit
- Inflation
- Unemployment
- GDP
- Globalization
- Foreign investment
In your opinion, did government intervention help or harm the economy before and after the panic of 2008? Would you have done anything differently?
Make sure you use research to back up your argument.
Sample Answer -What Caused The Financial Crisis Of The 2008?
The classic explanation of the causes of the financial crisis of 2008 is that frequent monetary excesses caused it. Monetary excesses led to a boom and ultimately a burst, which was inevitable. Prior to the financial crisis, there was a housing boom, which was followed by a burst. This led to defaults, thereby leading to implosion of mortgages and mortgage-backed securities in financial institutions. Between 2003 and 2005 the Fed held target interest rate at rates were significantly lower than the known monetary guidelines. Keeping interest rates in line with the monetary guidelines would have prevented the boom and burst. This had worked very efficiently in the previous two decades.
It was vital for the government to diagnose the causes of the problem early. However, during the early part of the crisis, policy makers wrongly deemed the crisis as one of liquidity. Therefore, they provided the wrong solutions. The Fed created Term Auction Facility to help in reducing interest rate spreads. However, its actions had negligible effect on the crisis. The government also reduced the target federal-funds rate from 5.25% to 2%. This had a negative impact as it increased inflation due to the reduction in the value of the dollar. The fiscal policies taken by the government strived to solve the immediate problem. However, their long-term impact was detrimental to the economy.
Use of subprime and adjustable-rate mortgages amplified the effects of the boom and burst. In addition, there was excessive risk taking, which was encouraged by extremely low interest rates. The government-sponsored organizations Fannie Mae and Freddie Mac were also encouraged to buy mortgage-backed securities, including subprime mortgages, which were very risky. Defaults led to a sudden increase in the interest rates in money markets, which triggered the crisis (Taylor, 2009).
This prompted the government to pass the Economic Stimulus Act in 2008. The aim of the Act was to send more than $100 billion to families and individuals, which would have promoted to spend more thus helping in jump-starting the economy. However, people spent very little money on the temporary tax rebates. The economic stimulus would have helped in reducing unemployment, which was very high. The solutions provided by the government worked in the short-term. The government also created Troubled Assets Relief Fund (TARP), whole sole aim was to prevent foreclosures, stabilize the financial system, and facilitate GDP growth. TARP made the government spend hundreds billions of dollars. As they increase government debt and deficit (Taylor, 2009).
The government fiscal and monetary policies in reaction to the financial crisis provided a temporary solution to the crisis. However, if the government did not intervene there would have been a total collapse of the U.S. economy. Therefore, government intervention helped in economic recovery.
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