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The Global Economic Crisis of 2008

Economic indicators for the current global financial crisis

It is not lost on anyone that prior to the start of the prevailing global economic crisis in September 2008, there had already been published countless business journals that sought to warn the various governments and investors alike of the looming danger ahead (Fackler 2008). Specifically, such articles cited the main culprits as the mortgage and investments banks, in addition to insurance firms. Evidently, this forecast turned out to be true, as we are now witnessing a crisis in the sub-prime mortgage.

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There are a number of indicators to the prevailing financial crisis that the UK, along with the other major economies, is facing at the moment. To start with, there has been a rise with regard to the rate of unemployment, as a result of the reduced number of openings in the job market, with the effect that the claimant count has also drastically increased

(Grant 2008; Fackler 2008). Furthermore, average earnings have plummeted greatly. In the UK for example, this was pegged at an average of 6.7 percent between December 2008 and February of 2009. This was an increase of 1.5, compared with the same time last year. On the other hand, unemployment levels reached 2.1 million in February, an increase of 486,000 in one year’s time.

By March of 2009, the claimant count had reached a high level of 1.46 million, which is an increase of 73,700 within only one month. It is worthy of note that ever since 1997, the claimant count has been on an upward trend (The Economist 2009). With regard to a deficit of the public sector, in terms of the prevailing budget, this was estimated at 11.6 billion pounds by March of 2009. This represents an increased debt of 7.7 billion pounds within only one year. As a result of a rise in deficit, the public sector had to increase its net borrowing in the same financial year, to stand at 19.1 billion pounds, up from 11.5 billion pounds the same time last year. Another indicator that a financial crisis looms large is an observed rise in the rate of inflation. In October 2008, the rate of inflation in England stood at a high of 5.2 percent. This was mainly driven by a rise in household and housing services (Torbat 2008), chiefly from heating gas bills. Increased food prices have also played a part.

There is also the issue of the rising cost of transportation owing to the escalation in fuel prices at the close of 2008. In the case of the credit crisis, this came about due to the failure by banks and financial institutions that had extended credit to investors and individuals to take into account control on tax (Norris 2008), resulting in bad debt write-off, coupled with a slowdown with regard to economic activities.

Relationship between national income and the different components of aggregate demand in a closed economy with a government sector

a graph of the relationship between the national income, and aggregate demand components in a closed economy with a government sector
Fig 1: a graph of the relationship between the national income, and aggregate demand components in a closed economy with a government sector (Source:Chrystal & Lipsey 2003)..

In a closed economy, it means that no imports and export transactions exist with other countries (Common & Sigrid 2005; Ambrose 2007). However, a closed economy with a government sector also means that a government shall have to spend on the national income. In light of this, the government may be seen to impact the equilibrium income of such a country in two quite distinct forms. To start with the equilibrium gets affected when the government decides to send on goods and services. Then, the disposable income of the various households will also be affected by government transfers, in addition to taxes (Kay 1996; Sloman & Sutcliffe 2004). If we were to take an assumption that both the transfer payments as well as the spending of the government were independent of each other, it then follows that the taxes shall become induced, as a result of ‘proportional income tax’.

What the impact of the government sector does to the above graph is that we get a new aggregate demand (AD) curve, in which the point of intercept is remarkably higher, as a result of elevated and autonomous spending by such a government. The imposing of taxes by the government to the various households of the economy ensures that this curve assumes a slope that is more flat, owing to the effect this has on the disposable income of the people. The implicating here is that in a case whereby the government decides to increase taxes to the taxpayers (since this is a closed economy anyway, and the government may not exports goods and services to obtain taxes), the waning disposable incomes of the people means that their propensity to spend also get reduced (Perman & Scouller 1999; Sloman 2004; Worthington et al 2004), out of the feeling that they are getting poor. As a result, the curve declines.

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How a housing market crash that reduces people’s wealth could affect aggregate demand and national income

A housing market crash means that the wealth of anyone given household also decreases (The Economist 2008). Conversely, negative equity is also seen to rise. The implication here is that these events are bound to have a greater impact on the confidence of consumers, as opposed to a case in which the prices of houses were rising. This is because oftentimes, investors are always optimistic that the process of property shall rise

(Nellis & Parker 1996), meaning that should the reverse indeed happen, then the confidence of the shoppers is reduced, and they are more likely to reduce their spending. What a market crash on housing does to the aggregate demand of a country is that this factor gets reduced, because the national income has also reduced.

Consequently, there is less money to spend, and this leads to a reduced rate of growth of the economy. Due to these developments, a country could be faced with a real recession. On the other hand, a market crash on housing means that the prices of property come tumbling down (The Economist 2008), with the effect that the inflationary pressure that an economy could be subjected to, somewhat gets eased. In such a case, central banks, such as the Bank of England, may be forced to reduce interest rates, to at least stimulate a positive rate of growth of the economy. Nevertheless, the housing market crash could be so severe that the confidence of consumers could have been deflated to such an extent that the attempts by say, the Bank of England may not suffice to cause a stimulated demand in the economy (McAleese 2004).

How the government could respond to restore equilibrium to the housing crisis

At full employment, it means that there is a balance between on the one hand, labour input and on the other hand, productivity or output (Grant 2008). This is because investors have a market for goods and services. When such a market expands, the labour has to expand in tandem. With a crash on the economy however, investors and businesses cut back on expansion, since consumers are sceptical to make any purchases. As a result, the investors produce lesser goods and services due to a shrinking market (Griffiths & Wall 2005).

As time goes by, they may be forced to lay-off workers, as a cushioning effect to the economic downturn. If such equilibrium were to be restored, what the investors require from the government is a stimulus package, so that they may hire more employees. Then again, it would not make sense to hire if there is no expansion in the market of goods and services. In this case, the government could offer tax incentives to investors (Common & Sigrid 2005), such as a tax credit, meaning that goods and services shall be more affordable to the consumers.

It could also be possible to reduce taxes that the consumers pay. Still, such policies could have repercussions to the government, as it means that the national income reduces (Besanko et al 2006). As such, the government shall; have to either reduce its spending, or borrow money externally to finance its operations. This latter strategy adds onto the national debt of a country, one that the tax payers shall have to offset in future.

a graph of the effect of reduced aggregate demand
Figure 2: a graph of the effect of reduced aggregate demand (source: Baron 2006)..

When the production (P) of a country is increased, there is a corresponding rise in the demand of both the services and the goods being produced. This is as a result of two factors, the wealth effect, and the effect of interest rate (Perman & Scouller 1996; Chrystal& Lipsey 2003). When a government is faced with a looming housing crisis, and at the same time there is no transaction ion both import and exports, the main weapon that it could use to sustain the economy is the use of incentive for purposes of enticing investors. Fro example, it could reduce the interest rate payable by the consumers. Consumers get to have more disposable income, thereby resulting in a wealth effect. However, this is not a popular idea, because when the consumer confidence is elevated too much, they tend to overspend, pushing on the prices of commodities, and the rate of inflation rises.

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Bibliography

Ambrose, E. P. (2007). “Dollar tumbles as huge credit crunch looms” Telegraph. Web.

Baron, D. P, 2006, Business and its Environment (5th Ed. London: Prentice Hall Besanko, D and others, 2006, Economics of Strategy. (4th Ed). London: John Wiley.

Chrystal, K & Lipsey, R. G, 2003, Economics for Business and Management. (10th Ed). Oxford: Oxford University Press.

Common, M. S, & Sigrid, S, 2005, Ecological economics: an introduction. Cambridge: Cambridge University Press.

Fackler, M. (2008). “Trouble without borders”. The New York Times. Web.

Grant, R. M, 2008, Cases to Accompany Contemporary Strategy Analysis ( 6th Ed). London: Blackwell.

Griffiths, A. & Wall, S, 2005, Economics for Business and Management FT. New York: Prentice Hall.

Kay, J, 1996, The Business of Economics. Oxford: Oxford University Press.

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McAleese, D, 2004, Economics for Business: Competition, Macro-stability and Globalisation (3rd Ed). New Jersey: FT Prentice Hall.

Nellis, J. G. & Parker, D, 1996, The Essence of the Economy (2nd Ed). New Jersey: FT Prentice Hall.

Norris, F. (2008). “United panic”. Web.

Perman, R. & Scouller, J, 1999, Business Economics. Oxford: Oxford University Press.

Sloman, J, 2004, Essentials of Economics. (3rd Ed). Ed). New Jersey: FT Prentice Hall.

Sloman, J, & Sutcliffe, M, 2004, Economics for Business (3rd Ed). Ed). New Jersey: FT Prentice Hall.

The Economist (2008). “Tightrope artists: managers of banks face a tricky balancing-act”. The Economist. Web.

The Economist (2008). “Structural cracks: trouble ahead for global house prices”. The Economist. Web.

Torbat, A.E. (2008). “Global financial meltdown and the demise of neoliberalism”Global Research. Web.

Worthington, I. et al, 2004, Economics for Business: Blending Theory and Practice (2nd Ed). New Jersey: FT Prentice Hall.

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