The credit crunch has also affected the banking system. The Lehman Brothers which was the fourth biggest investment bank went bankrupt as a result of the credit crunch. Specifically, the credit crunch affects the stocks and the bank loses profit, and then goes to a serious financial crisis. With the credit crunch many businesses can not get a loan, it directly affect the productivity of firms. If firms do not have capital, they can not make more goods available, so this shifts the aggregate supply leftwards. It means firms lose output, therefore lose profit.
(As diagram 2) The effects that the financial crisis has had are clearly visible. The US has a high unemployment and a low GDP growth, which is decline economy. Of course, as there’s a recession of economy, the US government has taken economic measures to offset this crisis. The US government followed Keynes theory, which recommends governmental intervention; then, the US government decided to “slash interest rates to 1 %”( BBC, 2008). The US government was trying to reduce the interest rates to increase money supply and encourage consumption.
Therefore increase the aggregate demand and also encourage firms’ investments during the recession, in order to keep high GDP growth reduce the percentage of unemployment. And then The US government capitalized banks and firms, it increased the aggregate supply. Consequently, these shift the aggregate demand and supply rightwards. As diagram 3 shows, the increased aggregate demand, the equilibrium raise from B to C and the output increased as well. And the more aggregate demand is; the more supply to be.
So the aggregate supply goes up with the aggregate demand increases. And then the equilibrium falls from C to D, but the output is increasing. (As diagram 3) The recession has clearly been a top priority for America’s new president, Barrack Obama. He has intensified efforts to stimulate fiscal policy through tax cuts to increase the aggregate demand. He has increased government spending to revive the economy, introduced tax cuts for low-income families, and corporate tax cuts to increase employment opportunities.
He follows Keynesians focus on the demand side effects of changes in taxation and government spending to increase aggregate demand. Increasing the government expenditure is good for all the people not just those who can afford services. In conclusion, I think more government expenditure will cause deficit. Maybe the recession will continue, or in the future will cause inflation. However, the policies of increased money supply can provide an incentive for people to consume and shift the aggregate demand, promoting economic growth. In my opinion after a few years, the economy of the US will bounce back.