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Recession Analysis 2007-09

1. Introduction

There was a recession in the United States starting year 2007. This recession continued into years 2008 and 2009 and ended somewhere in the middle of 2009. However, it is necessary to look at economic and financial indicators data for 6 months preceding and following the recession to accurately gauge it. When there is a recession, all economic and financial indicators show that the recession is in progress. This can be seen by carefully monitoring and evaluating these indicators. Further, these indicators also show the expansion phase, which follows the recessionary period. Therefore, it is essential to analyze a recessionary period from many angles and consider not only economic indicators but also financial leading and lagging indicators.

When a recession struck the US economy in 2007, the government took appropriate measures to deal with it. The Federal Government also adopted its policy measures, which were implemented through both fiscal and monetary policies of the government. No recession analysis is complete without taking into account policy response of the government. Therefore, this paper also looks at policy responses. 

2.2 Regulatory Response

The Federal Government and the Federal Reserve took policy measures to stabilize the economy during the period of recession. The Federal Government engaged in deficit spending to stimulate the economy. This deficit spending is done through government expenditure, which increases to boost the economy. The Federal Government engaged in open spending in order to help the economy and increase the production.

The recession, which started in December 2007 was touted as the worst recession since the Great Depression that struck US economy in 1930. In response, the Congress passed the American Recovery and Reinvestment Act of 2009, known as the Recovery Act. With this law, the Federal Government provided about $282 billion of fiscal assistance to state and local governments.

When a recession strikes, state and local governments' spending tends to decline. Reduction of state and local governments' expenditure  were more pronounced in this recession. However, revenue fluctuations are determined by state's tax structure, industrial bases, and economic conditions. Spending by state and local governments increases during economic expansion. This is in contrast to spending on safety net programs, such as health and hospital and welfare services, which tends to increase during recessions (GAO, 2011).

Likewise, the Federal Reserve also took policy measures to deal with financial crisis and economic recession. The US government responded to financial crisis and the ensuing Great Recession with aggressive fiscal and monetary policies. This resulted in a multi-pronged and bi-partisan response of the Federal Government and the Congress. Yet, these policy measures were dubbed as ineffective as well as they were misplaced. However, the economy remained weak even after recession had ended. This was also evident in the way the Federal Government provided unemployment benefits and the Federal Reserve considered additional monetary easing.

Still, it is clear that it was the response by the Federal Government and the Federal Reserve that prevented the Great Depression from engulfing the US economy. This happened because these policy responses supported and buttressed real GDP, jobs, and inflation. If the Government did not respond, the GDP in 2008 would have been lower by 11.5%. Likewise, in the absence of government response, about 8.5 million jobs would have been wiped out. Furthermore, it would also result in post-recession deflation in the economy.

Systematical analysis of effects of federal stimulus and quantitative easing done by the Federal Reserve indicate that the policy of the Federal Reserve was more effective and far-reaching than the response of the Federal Government. Still, overall effects of fiscal stimulus were great. This fiscal stimulus in total resulted in real GDP rising by 3.4%, unemployment rate remaining decreasing by 1.5%, and the economy creating more than 2.7 million jobs. Then, the Government had spent about a trillion dollars in fiscal stimulus by year 2010 (Blinder & Zandi, 2010).

Overall purpose of the Federal Government and the Federal Reserve is to provide fiscal stimulus. The Federal Government has a major role to play. However, as is was already discussed, the response by the Federal Government is not as effective as that of the Federal Reserve. The Federal Government gets the money through various laws that are passed by the Congress. Then, the Congress provides relief through these bills and all of this stimulus money flows to state and local governments. Then, these state and local governments engage in federal fiscal stimulus spending. This creates jobs in the economy and also has some repercussions for the inflation. However, the principal method of federal fiscal stimulus is through this deficit spending. In this situation the government gives tax rebates to the general public. At the same time, the Federal Government and other governments' expenditure is also increased considerably. This deficit spending is very conducive for the economy. It gives a quick stimulus to the economy and the real GDP grows to become equal to the level where it would have been without recessionary pressures. Then, cutting of taxes and increasing of government expenditure both work to provide economic stimulus. This also creates jobs, which would otherwise be lost due to recessionary pressures in the economy. This happens as production and services both post a slump during recessions. This results in massive layoffs in the economy. Then, it is not possible to create jobs in the economy without this deficit spending, which has a double effect.

Similarly, the Federal Reserve also plays a great role in providing the relevant stimulus in the economy. Rather it has been found that corrective measures of the Federal Reserve have even more power than those of the Federal Government. Then, the Federal Reserve goes on a monetary easing spree. The amount of broad money (M2) is increased in the economy. This is done through open market operations where the Federal Reserve increases liquidity of the banking system. As it was stated, the Federal Reserve sells commercial papers (CP) of 3-month and other maturities to commercial banks. This results in money supply increasing in the banking system. At the same time, the Federal Reserve also decreases the interest rate in the economy. This is generally referred to as the Federal Funds Rate in the United States. We have seen that the Federal Reserve had made this rate to equal near-zero rate. This was to promote inflationary pressures in the economy and promote investment. When the Federal Fund Rate dips so low, then investors have no reason to keep their money in the money market. Then, they start investing money in the economy, which also creates jobs in addition to more production and services in the economy. In this way, the monetary easing response of the Federal Reserve is the most effective fiscal stimulus.

The Contagion

US recession was not limited to the United States alone. It was contagious and spread quickly to other countries operating in the global economy. Therefore, it is important to assess this contagion by looking at economic performance of other countries in the world. If economies of other countries also showed signs of recession and its pressures, then it would mean that the US recession had a worldwide effect on the global economy.

Accordingly, it is important to analyze economic activity of another country in Europe. The LEI for UK had dropped in November 2007 and continued to drop until January 2009 (The Conference Board, 2009). This indicates that financial impact was indeed there and the recession in the US economy starting December 2007 also had its effects on UK economy in addition to other world economies. 

Conclusions and Policy Recommendations

It is clear that the most recent economic recession hit the US economy in December 2007. It continued to the influence the economy until the middle of year 2009. If to analyze economic activity of US economy for this period and beyond one year, it is possible to see that economic activity remained slow. By using the Leading Economic Index (LEI) it can be seen that it accurately predicts and maps economic activity in the country. It shows periods of recession and beyond. Furthermore, there are no blips in this index and it shows that the activity actually remained slow. In this way, LEI is able to determine strengths and weaknesses in the economy.

We also see that such recessionary trend is also mimicked by other economic indicators in the economy. For example, the Federal Funds Rate (FFR) and Commercial Paper (CP) rates for 3-month maturity commercial papers also corroborate LEI trends. The same was the case with real GDP. However, it was interpolated and did not accurately mimic the LEI.

As a result of the recession, the Federal Government and the Federal Reserve took policy measures to stimulate the economy. The Federal Government used the bills passed by the Congress to provide stimulus funding to state and local governments. Deficit spending was undertaken by the Federal Government. However, policy response of monetary easing by the Federal Reserve was more effective. Then, the Federal Reserve increased the supply of money in the economy and also lowered interest rates to near-zero level.

Accordingly, in line with the findings presented in this report, it is highly recommended that policy measures of the Federal Reserve should be adopted with widespread effect as they are more effective. This does not mean that the Federal Government has nothing to do with providing fiscal stimulus. Both policy initiatives act together to increase employment and production in the economy in the face of a deepening recession. Hence, the role of none of these actors can be underemphasized.

Likewise, we also found that the US recession had a global effect. Once the recession hit the US economy, it also had its ripples felt around the world. It was seen that contagion quickly spread to UK and other countries in the world. Then, the LEI for these countries also dipped as they felt shocks of the global recession. Such contagion was also accessible to other markets in the system and stock prices also showed the effects of recession in the economy. Therefore, these stock prices as measured by S&P 500 index also slumped during the period of recession. 

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