1.0 The Global Financial Crisis and its Impact
The recent Global Financial Crisis (GFC) initially began with the collapse of credits and financial markets, which caused by the sub-prime mortgage crisis in the US in 2007. The sub-prime mortgages were given to high-risk lenders (with bad credit history) who were in danger of defaulting, which eventually caused a global credit crunch, where the banks were unwilling to lend to each other. In October 2008, the collapse of the major financial institutions and the crash of stock markets marked the peak of this global economic slowdown (Euromonitor International, 2008).
Although the origin of the GFC might have been the housing and financial ...view middle of the document...
Today, the world’s economy has barely recovered from the crisis, it is important to evaluate what policies have addressed the impact of the GFC effectively. This paper argues that as economic instruments, as the tools of monetary and fiscal policies, quantitative easing, credit easing, stimulus package and tax cutting have been extremely important for the policy responses from the governments and central banks.
2.0 Responses to the GFC
When an economy is experiencing a recession, consumers reduce as much as spending before, businesses decline its production that means less people get employed, which causes more people stop spending. Therefore, a country’s government and central bank are expected to turn the economy into the opposite direction from where it is headed (Mathai, 2012). As the GFC swept down the economies around the world, fiscal and monetary policies were the two major instruments that government applied to saving their economies during the GFC.
3.0 Monetary Policy
3.1 Conventional Monetary Policy
Monetary was one of the key instruments for nations to respond to the GFC. For a country with floating exchange, monetary usually involves in setting interest rates and control the supply of currency. In the most cases, central bank has the responsibility for the country’s monetary policy. When an economy is healthy, the purpose of monetary policy is to achieve an inflation target, maintain a full employment rate, price value and ultimately, economic prosperity (Ehler, 2009).
Under the financial condition of the GFC, central banks started reducing their policy interest rate aggressively. In the United States, the Federal Reserve was forced to cut its policy rate from 5.25% in late 2007 to 0-0.25% in December 2008. The Bank of Canada was lowered to its lowest possible to 0.25% (Lane, 2013). On the other side of the world, the Bank of Japan was cutting its to 0.1% and the Bank of England was 0.5%. The GFC has resulted the declines in consumptions and business productions, which strongly shifted the IS curve to the left on the IS-LM model. That explains the wave of reducing policy interest rate around the world because a decline in interest rate reduces the cost of borrowing and eventually increased consumption. Moreover, if the interest rate maintains its position, the output would decrease even further (Chhabra, 2009).
3.2 Unconventional Monetary Policy
Despite that many countries had reduced their interest rate to the lowest possible, a number of unconventional monetary policies have also been applied to face the challenges of the GFC. Quantitative easing and credit easing are the tools of unconventional monetary policy (Ashworth, 2013).
Under conventional monetary policy, central banks try to boost economies indirectly through cutting interest rates. Quantitative easing occurs when an interest rate has reached its lowest, the central bank decides to increase the size of its reservation to purchase...