Question

What were the monetary and fiscal policy responses to the Great Recession? What were some of the reasons suggested for why those policy responses didn’t seem to have as large an effect as anticipated on unemployment and GDP growth?

Short answer

The fiscal policy in response to the Great Recession was increased government spending and the monetary policy was to lower the interest rate.

As the debt level was high, fiscal and monetary policies were ineffective in reducing unemployment and increasing GDP growth.

Step-by-step solution

Monetary and fiscal policy responses to the Great Recession

Government spending or purchase is a component of aggregate demand that can affect the GDP or income of the country. An increase in government spending increases aggregate spending and thus, results in multiple increases in the final income due to the multiplier effect. Considering this, Congress increased the government purchase to push spending forward and create demand for goods and services.This was used as a fiscal means to come out of the recessionary situation.

Similarly, the federal government lowered the interest rate to increase investment spending, thus shifting the aggregate demand curve to the right.

Failure of policies in changing unemployment and GDP growth

The policy action failed because of a large amount of debt. The fiscal stimulus only created a burden and thus was ineffective. The reduction in interest rate was also not effective as it did not increase the borrowing as assumed since many people were already in debt. Thus, the policies used were ineffective in reducing unemployment and increasing GDP growth.