The 2008 Global Financial Crisis and U.S. Economic Policy

Introduction

The economic crisis witnessed around the world — including in the United States — and the various efforts made by governments to restore stability to their economies raised fundamental questions about the strengths of the free-market system and what justifies state intervention. This paper aims to place the debate on government intervention and free-market efficiency in perspective. It also makes a case for the need to regulate financial institutions in order to achieve more stable economies (Aikins, 2009).

The economic crisis raised several questions about the role of state intervention in stabilizing economies, as well as the strengths and weaknesses of the free-market system. At the height of the crisis in 2008, governments of various industrialized countries — fearing that the situation might escalate further — took serious measures to prevent financial institutions facing turmoil from collapsing. The United States was at the forefront and intervened on a scale comparable to measures seen during the Great Depression (Aikins, 2009).

Market Society and Laissez-Faire Economies

The theory of laissez-faire economics is based on the model that production — whether of goods or services — is governed and controlled by consumers who are deemed to be rational in the choices they make. An idealized competitive economy is characterized by self-regulation, the free flow and availability of information, and the revelation of preferences and exclusion. The revelation of preferences, combined with the assumption that individuals are rational in meeting those preferences, constitutes the foundation of consumer sovereignty. Only exclusivity in the ownership and use of property can ensure the transfer of property and prevent people from using goods and services they have not paid for (Aikins, 2009).

The liberal, self-regulating state of the 19th century led to the emergence of what Karl Polanyi called "market society" (Polanyi, 1957, p. 250). The liberal state represented the interests of those who championed market-focused institutions. When World War I ended, embedded liberalism replaced classical liberalism and market society. Embedded liberalism focused on employment, growth, and redistribution, and was grounded in socialist principles (Ruggie, 1983; Polanyi, 1957). The need for state intervention in macroeconomics was further reinforced during the Great Depression. Economic stagnation made it urgent for states to intervene in order to guard against widespread unemployment (Gallarotti, 2000). As Marx had predicted, in their efforts to protect their capitalist systems from collapse, states adopted policies they had previously opposed — policies that encouraged the redistribution of resources to promote equity in society (Aikins, 2009).

The interventionist policies that emerged following World War I were intellectually legitimized by the Keynesian Revolution, which gained widespread acceptance as the Great Depression was drawing to a close. The war had demonstrated to capitalist societies that economic crises could be mitigated through substantial public expenditure. John Maynard Keynes later theorized the lessons that the capitalist state had drawn from this experience (Aikins, 2009).

Keynesian Model of Macroeconomics

Keynes believed that the goal of state intervention was to complement market forces in order to achieve high levels of economic activity and full employment, thereby enhancing the productivity of the liberal market (Kethineni, 1991). As a means of counteracting declining demand, Keynes proposed that governments increase public works expenditure — particularly on power projects, hospitals, roads, and schools (Brown, 1984). Most Western nations that adopted Keynesian views sought to achieve both social freedom and social justice (Mishra, 2001). The measures taken helped stabilize economies and supported economic growth (Aikins, 2009).

A central argument in Keynesian macroeconomic theory is that nations should use fiscal policy to counter recession by increasing government spending or lowering taxes in order to boost consumer spending. This means governments can take various measures to alter demand in the market. A drawback of these interventions, however, is their vulnerability to political motivations, which makes consistent regulation difficult (Aikins, 2009).

Conclusion

The economic crisis of 2008 resulted in an unemployment rate of 8.8% in 2008, accounting for approximately 2.8 million unemployed individuals. Projections at the time forecast unemployment rising to 11.4% in 2009 and 11.8% in 2010. The housing sector — where the effects were most direct and visible — collapsed by 20%, falling to $8.8 trillion from its 2006 peak of $13 trillion. Housing losses were closely tied to household net worth, with most Americans losing roughly a quarter of their net wealth. As a result, one in every five homeowners fell behind on mortgage repayments, and 4,500 new homeowners lost their homes. In the trade sector, the impact of the 2008 financial crisis caused a 15% drop in exports and imports in 2007 and a 26% decline in 2009 — a drop worth $29 billion, representing a 41% decline from 2007 levels. The U.S. auto industry was severely affected, with sales falling from over 15 million in 2006 to just above 10 million in 2009. The banking sector was the epicenter of the crisis, with numerous financial institutions collapsing. From a peak of over $2 trillion in private loan issuance in 2006, the banking sector contracted to approximately $150 billion in 2009 (Roubini & Mihm, 2012).