What Is the Economic Meaning of a Recession?
A recession is a notable reduction in the economic performance of a nation that lasts for more than a few months affecting labor availability and industrial performance. Boushey et al. (2019) also define a recession as a period of economic contract and decline characterized by lowered industrial activities and identified by a reduction of the GDP in two consecutive quarters. While there is no specific definition of recession, there is consensus that it is characterized by reduced output and a sharp increase in unemployment in a nation (Gertler & Gilchrist, 2018). In addition, other indicators of a recession are lowered household income, industrial performance, production, and retail sales.
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One of the most crucial demand-side policies is the fiscal policy. According to Boushey et al. (2019), fiscal policies are economic measures that refer to the use of government revenue to adjustment of tax policies to positively influence the economy of a country. From the definition of Gertler and Gilchrist (2018), fiscal policy implies actions taken by governments in an attempt to influence the aggregate demand. From a similar view, Sumner (2017) explains that during a recession, a government may use fiscal policies, which involve the reduction of the tax rates and increasing government spending to trigger economic performance. In the US, fiscal policy actions are enacted by Congress to stimulate the spending of the government and the reduction of taxes to raise output and help the economy to return to preceding status.
Another demand policy that is instrumental in managing a recession is monetary policies. Monetary policy is defined by Kuttner (2018) as the action taken by a country’s central bank to monitor and control the quantity of money in the economy through such activities as the modification of the interest rates, purchase and sale of government bonds, and forex rate regulation. The goal of the monetary policy is to encourage customer spending and increase borrowing for investment.
Sumner (2017) adds that the monetary policy can also be referred to as control of the money supply in the economy with the intention of attaining the macroeconomic goals, which include reduction and control of inflation, consistent growth, and liquidity. Notably, monetary policy implies the steps taken by the federal government in collaboration with the central bank with the aim of not only reducing the interest but also ensuring that unemployment is minimized during and after a recession.
Use of Demand-Side Policies during the Great Recession
During the great recession, the monetary policy was applied by the federal government to stabilize the economy. The measure included a reduction of short-term interest rates from 4.25% to almost 2.0% in the period between December 2007 and December 2008 to ease the economy and facilitate its recovery (Kuttner, 2018). The reduction of the interest rate led to increased liquidity as most consumers could afford to borrow. Consequently, businesses were able to run and expand, therefore creating employment opportunities. Boushey et al. (2019) note that to ensure a balance of the economic system, the federal government set to maintain a constant inflation rate of 2%. The aim was to curb the downward spiral of the economy.
The monetary policy did not yield much of the expected results as the crisis continued to rise. The continued increase of the recession prompted the government to further take another measure that was referred to as quantitative easing (Gertler & Gilchrist, 2018). The action involved the creation of bank reserves for the purchase of large-scale assets, such as treasury bonds and security, with the aim of increasing finance in the economy.
In addition, quantitative easing is also aimed at reducing the long-term interest rates for huge investors (Gertlerm & Gilchrist, 2018). However, these monetary policies did not solve the recession as by 2009, banks were not able to lend even with the reduced rates, and unemployment had risen up to 10%, the highest it had ever been (Kuttner, 2018). All the demand-side policies had to be applied to save sharply growing recession.
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To reduce the severity of the recession, the fiscal policy was applied. Through the American Recovery and Reinvestment Act 2009 (ARRA), the government authorized spending in such areas as infrastructure and education, which led to the expansion of the economy. Alongside the authorized spending, the ARRA also suggested the making of the tax cuts that would encourage the consumers to spend (Sumner, 2017). The increase in government spending is believed to have stimulated the recovery of the economy by the year 2011 as there was a registered growth of the GDP by 2.3% by the end of 2009 (Kuttner, 2018). There was a notable change after the application of the tax exemption, although at a slow rate.
However, it is notable that not all the aspects of the fiscal policy were effective in growing the economy. Sumner (2017) elaborates that the fiscal policy stimulus that focused on the tax cuts for the business was less effective. Reduction of the tax to lower-income households was more efficient in the elimination of the recession. In addition, the government spending was a more effective stimulus than the deduction of the tax. During a recession, Kuttner (2018) argues that the fiscal policy is highly efficient as the increased government spending leads to a boost of the capital in the economy. As a result, industrial performance grew, which opened opportunities for more labor.
Boushey, H., Nunn, R., & Shambaugh, J. (Eds.). (2019). Recession ready: Fiscal policies to stabilize the American economy. Brookings.
Gertler, M., & Gilchrist, S. (2018). What happened: Financial factors in the great recession. Journal of Economic Perspectives, 32(3), 3−30. Web.
Kuttner, K. N. (2018). Outside the box: Unconventional monetary policy in the great recession and beyond. Journal of Economic Perspectives, 32(4), 121−146. Web.
Sumner, S. (2017). Monetary policy rules in light of the great recession. Journal of Macroeconomics, 54, 90−99. Web.