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Tracy IFY business 3

Recssion

“The world economy is in the grip of the most severe recession since 1930s.
Banks are ailing and manufacturing industry is collapsing. Consumers have lost
much of their wealth and unemployment is climbing”

Explain the origins of the current crisis and the measures taken by the US
authorities to resolve it.

A recession is a situation of decreasing real GDP, falling incomes and rising

unemployment for two consecutive quarters. Nowadays the world is suffering the
worst recession, which means the economy has negative growth，banks are suffering
and manufacturing industry is falling. There are many symptoms show the economy
of the world is in a situation of recession. For example the house prices falling, a lot
of banks are collapsing and many businesses are declining. The value of money that
people have is depreciated so that individuals lose their wealth, then there is less
money running in the economy which leads to less production and high
unemployment, therefore the GDP is falling. In this essay I would like to analyse what
caused the current recession and what are the current policies of the US government
to solve the crisis.

From last year with some symptoms of the economic recession occurred, the world
economy hold the toughest recession. There are many reasons which have lead to
recession. The first cause is the credit crunch, which is the main reason leading to the
recession of the US. The credit crunch refers to a sudden shortage of funds for
lending, leading to a result of decline in loans available. And the sub-prime mortgage,
which means mortgage companies give inappropriate mortgage to people who want to
buy houses who have low incomes and poor credit. It is the fuse that causes a credit
crunch. Before the recession the house market of the US was booming. During the
recession the house prices have “fallen by a staggering 18% over the past year”

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(Economist, 2008). With the house prices falling and the increased interest rates result
in an expensive mortgage repayment, so the customers can not pay the money back.
Then mortgage companies take their houses but can not regain their loan, therefore
leading to the companies lose a lot of money, finally leading a credit crunch which
means banks have no money to lend or afraid to lend, so that there are less loans
available.

As we know, because the credit crunch reduced a supply of cash, many small and
medium-sized businesses can not get a mortgage. Therefore, they do not have enough
cash flow to run the business. As a result, many businesses go bankrupt, so many
people lose their jobs, and then they do not have enough money to afford a house or a
car etc. Hence, this shifts the aggregate demand leftwards and causes a declining in
manufacturing industry. As diagram 1 shows the output falls from Y1 to Y2.

Because the decreased aggregate demand, there is a movement in supply. We can see
from diagram 1, the equilibrium falls from E to F. With the decreased aggregate
demand, many manufactories lose sales. For example “General Motors said its sales
fell 45% compared with March 2008, Ford's sales dropped by 41% and Chrysler's by
39%.”(BBC, 2009) Generally, when the firms lose profit during the recession, they
would no longer use as many workers as they used to use; then, there is more
unemployment. As more people are becoming unemployed, there are less people with
purchasing. This is a vicious circle of the economy. The unemployment rate in the US
is up to 8.1%, it can measure as a high unemployment rate which leads to a falling
GDP in the US. The table below is the GDP of the US from 2006- 2008. Since 2006
the GDP of the US is decreasing year by year; it means the economy of the US
reached a recession.
Year Average GDP
2008 1.13
2007 2.05

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2006 2.78
Table 1 Source：Trading economics-online

The credit crunch has also affected the banking system. The Lehman Brothers which
was the fourth biggest investment bank went bankrupt as a result of the credit crunch.
Specifically, the credit crunch affects the stocks and the bank loses profit, and then
goes to a serious financial crisis. With the credit crunch many businesses can not get a
loan, it directly affect the productivity of firms. If firms do not have capital, they can
not make more goods available, so this shifts the aggregate supply leftwards. It means
firms lose output, therefore lose profit. (As diagram 2)

The effects that the financial crisis has had are clearly visible. The US has a high
unemployment and a low GDP growth, which is decline economy. Of course, as
there’s a recession of economy, the US government has taken economic measures to
offset this crisis. The US government followed Keynes theory, which recommends
governmental intervention; then, the US government decided to “slash interest rates to
1 %”( BBC, 2008). The US government was trying to reduce the interest rates to
increase money supply and encourage consumption. Therefore increase the aggregate
demand and also encourage firms’ investments during the recession, in order to keep
high GDP growth reduce the percentage of unemployment. And then The US
government capitalized banks and firms, it increased the aggregate supply.
Consequently, these shift the aggregate demand and supply rightwards. As diagram 3
shows, the increased aggregate demand, the equilibrium raise from B to C and the
output increased as well. And the more aggregate demand is; the more supply to be.
So the aggregate supply goes up with the aggregate demand increases. And then the
equilibrium falls from C to D, but the output is increasing. (As diagram 3)

The recession has clearly been a top priority for America’s new president, Barrack

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Obama. He has intensified efforts to stimulate fiscal policy through tax cuts to increase
the aggregate demand. He has increased government spending to revive the economy,
introduced tax cuts for low-income families, and corporate tax cuts to increase
employment opportunities. He follows Keynesians focus on the demand side effects of
changes in taxation and government spending to increase aggregate demand.
Increasing the government expenditure is good for all the people not just those who
can afford services.

In conclusion, I think more government expenditure will cause deficit. Maybe the
recession will continue, or in the future will cause inflation. However, the policies of
increased money supply can provide an incentive for people to consume and shift the
aggregate demand, promoting economic growth. In my opinion after a few years, the
economy of the US will bounce back.

Reference
BBC (2008), US interest rates slashed to 1%
Available: 02/04/2009
http://news.bbc.co.uk/2/hi/business/7696766.stm
BBC (2009), US car maker sales down for March
Available: 01/04/2009
http://news.bbc.co.uk/2/hi/business/7977922.stm
Economist, (2008), Markets and data, Daily chart, House price through the floor,
Available: 01/04/2009
http://www.economist.com/displayStory.cfm?story_id=11465476
Trading economics, Global economics research, United States GDP Growth Rate
Available: 01/04/2009
http://tradingeconomics.com/Economics/GDP-Growth.aspx?Symbol=USD

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