Stimulus Plans and the Economy
Economic recessions are a problem to economies because they lead to stagnation of economic activities that culminate to diminished credit opportunities for families and businesses, unprecedented job losses, lack of new employment opportunities fall in the value of homes, massive losses of pensions as a result of stock market failures, reduced wage earnings, increased healthcare costs and reduced spending on capital investments. This means that purchasing power of consumers and companies alike is significantly reduced hence overall reduction in real aggregate demand. Such occurrences precipitate economic crises such as closedown of businesses because of diminished domestic and export markets for manufactured goods. Recession also hampers the ability of governments to deliver services adequately as a consequence of shortfalls in tax collection. Recession further leads to housing crises as foreclosures become more eminent as lack of credit opportunities make it impossible for many individuals to finance housing loans and mortgages. Recessions also leads to huge deficits in the balance of payments for a nations import and export trade, leading to high levels of indebtedness. It is therefore evident that recessions can cause the poverty index of a county to increase as country can no longer support the creation of new jobs, export of manufactured goods, while the prices of essential commodities such as oil drop drastically as a result of reduced demand.
Implications of the Economic Recession
Financial mismanagement at the Wall Street saw the unprecedented collapse of the mortgage industry and plummeting stock markets all at one go. The big question that begs in the minds of many is why did the United States fall prey to the economic meltdown despite the countrys status as the worlds economic superpower It is equally surprising that the US government opted for the bailout plan and yet the country is the home of free market economy. Arguably, the 700 million bailout plan for US banks may be perceived as a conceptual contradiction to the principles of free market economy which prohibits government intervention in markets. Indeed, the concept of free markets economy is based on the reliance of market forces to determine the direction of the economy (Krugman, 2009). But a close look at the current economic crisis in the United States confirms that the bailout plan was needed badly. For instance, the collapse of Lehman and the subsequent American International Groups takeover by the federal government in September 2008 put banks to high alerts as many banks responded to the fragile situation in markets with a risk aversion strategy of acquiring treasury bills rather than giving out loans.
Moreover, interest rates on loans nose dived to all time highs to the disadvantage of business and individual borrowers. If the principle of free market economy was to hold, banks should have taken the advantage of the high interest rates to make loans and shore up the credit markets. However, such a market oriented mechanism did not and is yet to happen because the banking sector has been characterized by consistent nervousness, one of which is the fear that solid borrowers today may crumple in the near future should the US economy fail to take an immediate upturn (Foster Magdoff, 2009). These particular fears can be traced back to the 1930s depression which disintegrated into an elongated recession, and brought down most of the businesses that were in the finest of shapes during the depression phase. As David Leonhardt points out in his article titled Lesson from a Credit Crisis When Trust Vanishes, Be Worried and contained in the October 12, 2008 issue of the New York Times, the position of US banks in the lending markets has further been complicated by the tendency and preference of banks to hold long-term assets and short-term debts.
As such, banks must be able to borrow short-term loans in order to offset the short-term debts effectively. Unfortunately though, the inter-bank lending opportunities also dried out as lending banks developed more reservations about extending short-term loans to borrowing banks. The collapse of Wachovia Bank is one such example of a bank that collapsed as a result of capital hoarding by likely lenders (Leonhardt, 2008). With sources of short-term loans having been diminished by the current credit crunch prevalent in America, the bailout plan stands out as the most probable solution for the besieged American Banks.
The impact of the financial bailout plan impacted on the economic consumption habits of consumers in the United States. From an economic perspective, government expenditure, usually referred to as transfer of payments improves consumers spending habits through increased savings and reduced interest rates (Leopold, 2009). The consumers propensity to consume is largely determined by distribution of wealth and anticipation based on past experiences. Therefore, as consumers get accustomed to the anticipation of higher income, the marginal propensity to consume rises to its long-run level (Livesey 2009). Marginal propensity to consume refers to the total consumption divided by the total national income of a country (Livesey 2009). When economic growth stagnates, the national income will subsequently reduce and market confidence will be significantly eroded. Such converse movements of income place the short-run propensity to consume above the long-run levels (Livesey 2009). But it remains unlikely that the stimulus plan will assert immediate impact in the consuming habits because, according to Professor Friedman, the income hypothesis demonstrates close relationship between anticipated permanent income and actual expenditures. So for positive changes in economic prospects to take effect, there will be some time lapse, usually referred to as lagged adjustment.
The benefits of Stimulus Plans to Economic Growth
Economic growth is always beneficial because it is the only way through which an economy can achieve high living standards for individuals through creation of many jobs that pay high wages and substantive health and social benefits. In the United Kingdom, for example, statistics from the Reuters EcoWin indicate that steady economic growth since the early 1990s through to 2007 evidently gave rise to increased employments opportunities with employment having risen by 26.47 million to 29 million from a paltry 2.53 million during the period. This in turn endows consumers with high purchasing power thereby stimulating demand for goods and services. Moreover, economic growth leads to increased demand for raw materials, manufactured products and capital investments, thereby stirring successive profitable business cycles which enable companies to create new employment opportunities. Therefore, economic growth accelerates wealth acquisition through increased capital investments and increased investor confidence as well as unprecedented growth of small, medium scale and large scale businesses, particularly attributed to emergence of good news from the stock markets and increased access to credit facilities. Economic growth further improves governments spending on infrastructure projects and service delivery through increased tax and payroll deductions for social benefits. Most importantly, economic growth facilitates the emergence and development of new, cleaner and energy efficient technologies which release lower carbon quantities to the atmosphere. Therefore, economic growth is always beneficial in a variety of ways which improve the quality of lives of individuals.
The statement further confirms the concerns of economists that despite being constituted of some of the richest countries in the world, particularly the the U.S and the Eurozone, experienced hastened economic decline only comparable to that of the economic depression of the 1930s. The advantages of International Trade not withstanding, the individual economies of the rich nations were at their lowest states in recent history. It is little wonder that despite an early detection of property crush in the US and some parts of Europe, the economic advantages of regional economic block memberships had little impact in averting the problem. The economic decline in the US was particularly attributable the failure of th financial markets but also to the decreased demand for heavy manufacturing machinery and capital products as well as wage and labor inflexibility, factors that have contributed to high rates of unemployment throughout the country. The enhanced job security for workers in the majority of States within the US not only makes it difficult for companies to lay off workers but also made it difficult for young workers to gain employment, a situation that saw the average unemployment rates rise to all time high.
Review of the Stimulus Plans in the U.S
The economic meltdown in the U.S. was one of the most debated about issues in the last quarter of 2008. According to Minsky (2009) the period was marked by series of financial bailouts, as well as takeovers and buyouts of some of the most successful US companies in the financial services sector in a manner that baffled investors and economists alike. A clear manifestation of the impending economic crisis in the US financial sector occurred in July 2008 when a bailout plan for Indy Mac Bancorp failed miserably. This was later followed by a series unexpected collapse of investment banks and giant financial institutions that included Freddie Mac and Fannie Mae on September 7, 2008, Merrill Lynch on September 14, 2008, Lehman Brothers on September 15, 2008, AIG on September 16, 2008, Washington Mutual September 25, 2008, and Wachovia Bank September 29, 2008 (Minky, 2009). It was this shocking trend that prompted congress to approve the controversial 700 billion bailout plan on October 3, 2008 to rescue the US banks and entire financial system from further collapse. The Fed and the treasury under the guidance of Fed Chairman Paul Bernanke and Treasury Secretary, Henry Paulson respectively led concerted efforts to ensure strict and successful implementation of the US financial bailout for financial institutions.
There is no doubt that the 700 billion financial bailout plan for big banks was a new process that had been designed and prototyped successfully. The stimulus and economy recovery plans in the US created multi-billion dollar budgetary deficits (Krugman, 2009). However given that the simulation and modeling tools for the implementation of the bailout plan demonstrated high likelihood success, adequate structures were put in place to check the logical operations of the program. It was important for the treasury and the Federal Reserve Bank to ensure that all aspects of the bailout plan were handled sensitively and with due reference to the conditions set by the Congress. However, as Krugman, (2009) pointed out, it is important to note that although the dwindling economic prospects for the United States came to the fore in third and fourth quarter of 2008, the crisis had actually begun taking shape in the last quarter of 2007. For example, according to statistics contained in the New York Times of Sunday, October 12, 2008, one of the earliest financial bailouts happened in December 12, 2007 when the central banks across North America and Europe detailed a plan to cushion banks with a 90 billion short-term financing plan (Minksy, 2009). The statistics further confirm that the US Federal Reserve offered another 200 billion 28-day loans to banks in America in March 7, 2008. This was followed by another 200 billion bailout for investment banks which involved exchanging mortgage-backed securities for treasury securities (Minsky, 2009). Therefore, the financial meltdown of September 2008 was only but a culmination of a crisis cycle that sparked off in 2007.
Apparently, credit is a key economic ingredient without which no economy can flourish. The economic crisis in the United States was adequate testimony to the reality that diminished or complete freezing of credit opportunities ultimately render businesses as well individual investors dynamically dysfunctional and operationally unproductive thereby disabling significant potions of economic growth functions. That is why the Wall Street had to be revived at all costs because like it or hate it there can be no credit markets in the United States without the Wall Street (Gaffen, 2008). Lending taps had literally dried up, and investors requiring financing for large scale acquisitions needed to approach more than one lender so that they can acquire multiple small loans from different lenders. Such inconveniences affect project implementation timelines for such investors.
The Implications of the Stimulus Plans on the US National Budget
In order to avert an unfortunate eventuality for the economic crisis, the financial bailout for big banks was taken a notch higher. For example, the Federal Reserve adequately provided lending opportunities for rescue funds to distressed financial institutions but also bought assets experiencing serious financial distress. The Feds buying spree was evidenced by its recent acquisition of the American International Group, Inc. (AIG). According to Real Time Economics, a Wall Street Journal blog, the AIG rescue plan included 40 billion buy out of the collateralized debt obligations (CDOs) as well as the buyout of AIGs mortgage securities by the Fed. The later AIG rescue effort added to the earlier rescue plans of 85 billion and 37.8 billion which were initiated in September and October respectively 2008. The AIG example illustrates just how far the United States government was willing to go to restore the financial capacity of the big banks and financial investment institutions. The United States government also vowed to provide an additional 200 billion to finance securities purchases on wide ranging loan products by investors (Hilsenrath Solomon, 2008).
The United States Treasury and Federal Reserve Bank also spent 250 billion of the bailout funds to assume the equity of the United States big banks and other financial institutions (Minsky, 2009).
Ultimately, the treasury had exhausted the 350 billion of the 700 billion program by the beginning of 2009. According to Minsky (2009) the Treasury was yet again be required to seek approval from the Congress to access the other half of the of the financial bailout fund. With some lawmakers having already expressed reservations about the Treasurys and the Feds decision to spend some of the bailout fund in buy-out and acquisition programs for distressed assets, one cannot rule out a looming showdown between the Treasury and the Congress. Considering the fact that America was undergoing political transition amidst an economic crisis, the financial markets were at the risk of crumbling drastically should the congress have objected to sanctioning the remainder of the bailout funds (Minsky, 2009). Therefore, the Lawmakers had to expedite the release of the remaining portion of the bailout funds because extended debates and reluctance on the part of Congress to commit more funds from the countrys budget would have jeopardized the entire economic recovery program.
As such, should the United States have delayed to unveil the ambitious economic stimulus and financial bailout program, the US economy could have headed to its worst decline only comparable to the great depression. Just like the great depression which began in 1929 and culminated to catastrophic recession, the economic crises in the United States and around the globe are centered on the issues of credit crunch (Krugman, 2009). The Wall Street is considered to have been entirely responsible for the economic woes and the subsequent credit crunch in the United States. The great depression remains the best reference of what the US and the global economy in the United States was bound to lose should the bail out plans have fallen short of the targeted objectives (Krugman, 2009). For example, the close down of hundreds of banks during the great depression caused what economic experts refer to as lose of information capital. This was a situation whereby bank officers who had accumulated important knowledge in the credit sector disappeared to oblivion. So, when the economy finally picked up, the banks found it difficult to loan individuals and businesses because the new bank officers could not ascertain the reliability of borrowers.
Therefore, the billion dollar bailout plan for banks and financial institutions in the US was intended to avert risks that can otherwise spell irreversible doom for the globes economic superpower. For example, the US Congress called on the Treasury and the Fed to ensure that all banks benefiting from the bailout fund extend the same to the public by increasing the volume of lending to businesses and individual borrowers, apart from lowering interest rates and easing the prevailing tight lending restrictions (Minsky, 2009). The US lawmakers also wanted the Treasury and the Fed to ensure that the compensation packages for top bank executives are subjected to tougher and stringent measures to ensure that the executives do not draw bonuses and other individual performance benefits from the bailout funds.
The prevalence of high unemployment rates in the US is best illustrated through a simple demand and supply analysis. The prevailing deficit in the demand for labor relative to the supply of labor in the country is a manifestation of high wages set above equilibrium levels. The Michigan State, for example, offers not only high wages per hour in its manufacturing industry but also long vacations and generous social insurance benefits, resulting to large labor surplus because of low worker turnover and lack of new employment opportunities. Leopold (2009) noted that wage inflexibility in the US is a problem which stems from the difficulties of adjusting the non-wage costs which employers must pay to health insurance and social security because such decisions are politically influenced and beyond the control of firms p. 131. For example, States have in the past experienced workers resistance in the form social protests and strikes against any cuts in social benefits yet it is difficult for firms to overcome the adverse effects of economic recession without cuts in labor compensation. Consequently, foreign firms remain largely discouraged from setting up new plants in the country whereas domestic firms are looking to expand their operations from abroad. This is why the US had to brace for increased unemployment levels during the current global economic crisis through the introduction and implementation of the economic stimulus plans.
Conclusion
The main concern with the entire economic stimulus package is the direct government intervention in the US economy, a move that is undermining the principles of free market economy. This is because there is no way the government can commit the taxpayers money to economic recovery without putting into place stringent regulatory measures to ensure proper use of the money (Foster Magdoff, 2009). Nonetheless, the financial bailout plan for banks does not sound a death knell for free market economy but rather serves as a capitalist intervention designed to restore capacity and confidence in the US financial markets. The United States government cannot afford to abdicate the responsibility of ensuring the stability and growth of the gross domestic fixed capital formation which forms the countrys major portion of investments. Regardless of the impact of the stimulus plans to the budget of America, failure the shore up the economy spells doom because once the gross domestic fixed capital formation stagnates, the United States government, banks, companies and households will be rendered helpless because there will be no new investments, schools, factories, hospitals, houses and roads (Foster Magdoff, 2009). The economic recovery will be able to close the countrys growing multi-billion budgetary deficits over time.