Role of Monetary System

Felipe Medalla (2009) describes Ben Bernake’s assessment of the roots of the financial crisis in the global sense. As shown in Figure 1, the collapse of huge and unprecedented U. S. housing bubble was the primary cause of the global financial crisis. Aside from the problems in the U. S. housing mortgage, there was also an extensive decline in underwriting standards. The large credit boom was due to breakdowns in lending oversight by investors and rating agencies. Also, increased reliance on complex and opaque credit instruments turned out to be a very bad assumption about risks.

Fall in the US imports (Figure 2) also preceded the financial meltdown and the contraction of the US Gross Domestic Product (GDP). The credit bubble in U. S. also allowed the Americans to live beyond their means. The American consumer become the largest engine of growth wherein they accumulated $6. 2 trillion worth of borrowings from 2000 to 2007. Martin Hutchinson (2008) characterizes the current recession in the United States to follow a U-shaped pattern of downturn and recovery.

To compare the pattern with what is happening in the US economy, the output started to decrease in the 3rd quarter last year and continues to decline in the first quarter of 2009 and is expected to go down further in the mid year. As it approaches the most bottom part, a recovery will now take place in a gradual manner. This is different with another pattern which is V-shaped wherein an economic slump will be followed by a dramatic rebound leaving no period of depression. Hutchinson (2008) argues that most recessions in the modern period have a U-shape pattern of recovery as compared to the V-shape.

When recession occurs, the governments incur budget deficits while central banks decrease their interest rates to stimulate the money supply. This measure of the central bank serves as a cushion against a deeper downturn. However, it also slows the recovery speed, as the natural stimulus from a shallow downturn is weaker while the government stimulus fades off after some time. It was seen during periods of economic setbacks in 1991 and 2001 where the government stimulus were strong which prevented a heavy downturn but slowed the recovery.

Hutchinson (2008) also introduces a possibility of a W-shaped, double-dip recession to happen. The U. S. already experience this pattern from 1979-1982 where the first dip was caused by increased interest rates beyond normal levels to paralyze economic activity. After a monetary relaxation, the monetary policy was tightened once again in the latter portion of 1980. That resulted to the second dip. On that time, government stimulus was not enough which signified that the downturn was really deep. It was soon followed by a strong recovery in 1983.

Nouriel Roubini (2008) argues that there is a delusion that the recession the U. S. and other countries are experiencing will be short and shallow like the V-shape pattern. There exists a certainty that this will be long and U-shaped which can last at least for two years in the United States. Also an L-shaped recession which is experienced by Japan during the collapse of its real estate and equity bubble is possible to also happen in U. S. There are some who are optimistic about the current crisis in the United States. According to U. S.

Federal Reserve Chairman Ben Bernake, the America’s “worst recession” in decades will be short-lived and the economy will recover by 2010. He also predicts that no more large banks will close and he is positive that this recession will come to an end this year. But he addresses the politicians to be vigilant in addressing and suppressing financial meltdown that was evident last year. On the revival plans by US President Barack Obama, he mentions that the biggest risk apart from the $700 billion bailout money is that if we don’t have the political will to end this crisis.

Aside from that, he pleads for firmer regulatory reforms to deal with risks in the system created by an institution that is too big to fail like the American International Group. Right now, banks in the United States are undergoing a stress test in order to determine if they have the sufficient means to survive the crises. Bernake argues that the problems pertaining to US banks can be suppressed in a secured manner. Assessment Findings from scholars and economists explain how the financial crisis in the United States started.

Reports from the media cover the views of the politicians in suppressing the downturn of the economy. Also, the insights from the different institutions like the US Federal Reserve determine the current actions and the needed tools in preventing the worst and push for recovery. The US monetary system like the fiscal measures by the government has a crucial role in dealing with economic conditions like the one we are in right now.

References:

Agence France-Presse. (March 19, 2009) End in sight of US Recession: Bernake. ABC News. Retrieved 18 March 2009 from http://www. abc. net.au/news/stories/2009/03/16/2517009. htm Hutchinson, Martin (December 26, 2008) What Shape Will the U. S. Recession Take: U, W or ‘Bloody L? ’. Money Morning, The Money Map Report. Retrieved 18 March 2009 from http://www. moneymorning. com/2008/12/26/recession-shape/ Medalla, Felipe. (January 15, 2009) The Global Financial Crisis: Implications on the Philippine Economy. University of the Philippines, School of Economics. Roubini, Nouriel. (Novemeber 14, 2008) From Financial Meltdown to Global Depression? Project Syndicate. Retrieved 19 March 2009 from http://www. project-syndicate. org/commentary/roubini8