A government should intervene to close a gap between actual GPD growth and potential GDP growth in a recessionary gap. A recessionary gap is caused by negative spending shocks and/or a decrease in the velocity of money spent that pushes the AD curve down and to the left. With a recession, along with fear in investments, and cut-backs in consumer spending, a needed increase in spending growth is not likely to occur (unless a positive spending shock miraculously manifests itself or a real shock pushes the Solowe curve to the right) without money being injected into the economy to increase the spending growth. With Keynesian prescriptions for recessionary gaps, the Federal Reserve applies powerful expansionary policies to inject money into the economy. Such policies are monetary policy tools that stimulate the FED's FOMC, such as an increase in buying securities from banks (thus causing banks to increase loans), lowering the required reserve rate (creating excess reserves for banks to lend), and decreasing the fed funds rate or decreasing the discount rate. These actions can only be taken by the the Federal Reserve (government), and without an intervention a recession can last much longer or worsen as consumer confidence plummets causing even more money to be pulled out of the system, pushing the AD curve even farther down and to the left. Without a governments intervention during a recessionary gap (like President Obama's "bail out" and "stimulus plans" following the 2007 credit/home crash), a recession may turn out to be potentially catastrophic and long lasting.
No comments:
Post a Comment