The financial rescue package when implemented further targets to stimulate inter-bank lending. Money market funds dealers in the securities and hedge institutions have been unregulated in America and for many years acted as quasi bank institutions. New regulation has seen non bank financial institutions transform into commercial banks examples being Morgan Stanley and Goldman Sachs. (economist. com) Compared to Britain, the US economy has experienced slower rise in consumer prices for commodities and faster easing of inflationary pressures after a recession.
Any economy in the world is subject to fluctuation in output. The economy goes through an alternating pattern of a boom and a depression. The stages of boom and depression are interspersed with recovery and recession. Adding all producing firms in an economy together represents the aggregate output. A business cycle experienced by firms comprises output expansion in boom which indicates favorable economic conditions followed by contraction in output during a recession till the economy recovers.
When there is a reduction in output which is represented by the real gross domestic product (GDP) for about 5-6 months that is two consequent quarters an economy is said to be in recession. (Sigel 20) America has experienced over 46 recessions in a period of time 1802-2006. A value of sub prime property and stock plummets during a recession as consumers are skeptic about their investments. Consumers who panic when faced by an imminent recession make fast sales on risky ventures like stocks, shares and bonds to cut possible losses.
The government intervenes in the economy to minimize the magnitude of and severity of a booming recession. The Fed reaction in a capitalist environment has been viewed by critics as a socialist idea. During a recession, the Fed encourages spending by guaranteeing deposits and offering bail out packages for heavily indebted financial institutions. Lending by banks results in consumer increased purchasing power. Economist analyze spending patterns by the examining the various commodities that form the consumer basket.
The spending by consumers forms aggregate demand which provides a market for producer goods. This in turn stimulates production and hire of resources both human and material. The total amount of goods supplied in the market forms the Aggregate supply (AS). The interaction of AS and AD curves yields the equilibrium output and prices. The economy can recover from a recession through the business cycle whereby the high inflation results in reduced spending. The reduction in demand for commodities forces firms to reduce production by laying off workers and hiring less input.
The reduction in production causes the high prices and economy recovers. The fed does not with the economy to undergo a severe recession thus intervenes to correct the market imbalances quickly. The Philips curve is used in economics to illustrate the negative relationship between inflation which lies on the (x /vertical axis) and unemployment level which lies on the (y / horizontal axis). Market conditions dictate a trade off between unemployment and inflation. The Phillips curve slopes downwards from left to right and almost asymptotic at the low inflation -high unemployment part of the curve.
Expectations are found to affect the current value of inflation in the sense that when people expect inflation rates to rise, in future period; the will revise their current inflation value and workers demand increment in the wages. The Phillips curve describes an inverse relationship between prices (Inflation) and level of unemployment. The Phillips curve shows the interaction of AS – AD curves wages in the short run that is for 3 months to 1 year as assumed to be constant. (Deeparshree and Vanita 2 ). Workers who earn wages forecast the future price level when negotiating contracts with producers (firms).
The wage increment is designed to ensure workers receive real wage increment fully employed. The wage level is set by firms at the point of intersection of the AS curve and full employment output level. At unchanged aggregate supply level, inflation (rise in price level) results in fewer workers employed. (Wessels 243) The increment in wages ensures inflation does not erode the purchasing power for workers.
Taub ,Stephen Small Businesses Bitten by Credit Crunch CFO. com | US May 2, 2008 http://www. cfo. com/article. cfm/11319328? f=related Leonhardt, David US recession appears unavoidable Last visited on 17th Nov 2008.