TABLE OF CONTENTS

1.0 Introduction

In 2007, the financial crisis triggered by liquidity shortfall in the United States (US) banking systems has dragged the world economy into recession. The impacts were devastating. It affects most developed nations such as United Kingdom (UK), Japan and European countries and also the emerging economies like Korea, Russia, Brazil, India, and China. The liquidity issues of the banks killed well known financial institutions, followed by downturns in stock markets around the world. The collapse of property markets raises the non performing loans (NPL) in banks. The oil price surges over hundreds of dollars per barrel. Collectively, all these crises have put tremendous pressure on US economy. In terms of economic variables, the US economy suffered great fall in GDP at record rate, significant rise in unemployment rate at record high, homes sales at record low and so on. It is considered the worst financial crisis after the Great Depression in 1930s. As such, governments in other countries all around the world have no choice but to engage in economic policies to stop their economy plunging deeper into recession. Many were hopeful that these new policies would help to economy recover, but the fact is no one knew for sure whether they would. This paper will look into United States (US) and discuss how government and central bank react to such global economic crisis. We discuss types of macroeconomic policies adopted to prevent US economy to continue fall into recession.

2.0 Background of US Economy Before that, it is useful to look at how US has performed economically before crisis. Lets look at economic variables of economic growth like potential GDP and actual GDP, unemployment rate, inflation rate and others. 2.1 Gross Domestic Product (GDP) GDP is the total value of all new goods and services produced in the economy during a specified timeframe normally a year or a quarter. Macroeconomist uses GDP to measure the size of the economy and tells how countries are performing relatively to each other. As shown in Figure 1, for the past 40 years, the US real GDP has been growing averagely at 3 percent (Taylor 2010). It sounds little but it means the real GDP has more than tripled. The US production is greater than the sum of production by Japan and Germany, that is what made by all workers, machines, and technology in these countries (Taylor 2010).

Figure 1: US Gross Domestic Product (1960 2010) Positive and continuous economic growth will improve and benefits economic well being of individuals and is measured by real GDP per capita. Increasing real GDP per capita increases the standard of living in the economy. When real GDP changes, other economic variables such as unemployment, inflation and interest rates changes as well. Looking at these variables gives a better picture on how economy performs during bad and good times.

2.2 Unemployment Unemployment rate is the percentage of available working force that is actively looking and ready for a job but unable to get one. Normally unemployment rate is high during recession period because people get laid off and is hard to get new jobs. Figure 2 shows that unemployment rate increase rapidly during recessions. It is evident the recent crisis has caused a steep increase in unemployment from 2007 to 2010.

Figure 2: US Unemployment Rate with Recessions In 2008, the recession has killed about 2.6 million jobs in the US economy. On one single day, about 50,000 workers were laid off by firms across the country and about 170,000 jobs were eliminated on the first month of 2009 (Herbst 2009). A recent labour statistic report by US Department of Labour states the number of people who are unemployed for more than one year has increased significantly since the recession started in December 2007. They are mostly men aged between 25 and older. (Spreen 2010).

2.3 Inflation Besides output and unemployment changes over time, inflation changes also. Inflation is basically the increase in price averagely for all goods and services over a period. For past 40 years, inflation increased before recessions and decreased during and after recessions (Taylor 2010). The opposite is deflation, a rare occurrence over a period where inflation is negative and the average price level falls. It almost happened to US economy. Deflation can be serious issues. No one knows better how devastating the impacts of deflation than Japan, which has jeopardise Japans growth over a decade till now. Now, this poses great challenge to US government as they are contesting whether to cut spending to boost the weak economy or keep stimulating it worrying to do so will cause inflation and record high deficit. US have been running trillions of deficit for two year consecutively (Colvin 2010). Famous economist like Paul Krugman worries US economy would moves closer to deflation (Krugman 2010). Deflation if happened would lower down prices, which would cut into profits of businesses. In response, firms will cut resources like labour or capital investments, thus bring down consumer buying powers. Besides, it causes deflation spiral, a situation where consumer adopt a wait and see attitude that will delay their purchasing decisions in anticipating for lower falling prices on goods and services. The latest consumer price index (CPI) shows declining trend in second quarter of 2010, where core inflation rate had dropped to record low at about 0.9 percent (Lee 2010). Figure 3 shows the inflation of US since 1910. It is evident the inflation is on the low side.

Figure 3: US Inflation Rate (1910 to 2010)

2.4 Interest Rate Another variable to look at is the interest rates such as mortgage interest rate and savings deposit rate by banks to public, the Treasury Bill rate by government to public, and federal funds rate charged by federal banks to others banks on short term loans. Interest rate is powerful as it determines or influence peoples economic behaviour. In history, interest rates rises before recessions and decline during and after recessions. In 2008, the Fed fund rate was reduced to almost zero percent in order to increase money supply in the economy as an intervention to curb prolonged recession and to stimulate the economy (Figure 4). Such intervention reduces cost of borrowings and injects all kinds of loans into the economy.

Figure 4: US Federal Fund Rates

3.0 Aggregate Demand Aggregate demand (AD) is the total demand for goods and services or real GDP by households, firms, governments and foreigners. AD curve shows the relationships between price and quantity demanded (Figure 5). When price increases, real GDP will fall due to decline in demand for quantity of real money, price of present goods increase relative to future, and price for foreign products decreases in relative to domestic goods (Panel A). Conversely, when price falls, AD increases (Panel B).

Figure 5: Changes in Quantity of Real GDP Demanded AD changes often and thus often shifts. The influences that shift the AD curve are fiscal policy, monetary policy, international factors, and expectations. AD decreases (shift leftward) when fiscal policy decreases government spending or increase taxes, when monetary policy cuts money supply or raise interest rates, when exchange rate strengthen or foreign income weakens, and when expected inflation or expected profits decline. Conversely, AD increases (shift rightward) when above factors are opposite (Figure 6).

Figure 6: Changes in Aggregate Demand

3.1 Fiscal policy Fiscal policy is a demand management policy government used to fight recessions, to minimise impact of recessions and to stabilise economic fluctuations when it occurs by stimulating aggregate demand. The primary tools used include changes in government spending and taxes to influence the aggregate demand. During recession, demand for goods is low due to demand shock caused by collapses in property market, stock markets, financial markets, and also rapid rising in petrol prices. These collapses create uncertainty that forced households to save more and spend less. Besides that, failing banking sector tighten lending rules due to credibility issues of borrowers, thus making access to credits tough for firms. This reduces capital investment by firms. Collectively, aggregate demand declines and shifts the AD curve from AD1 to AD2. When this happened, the price level goes down and the real GDP declines (Figure 7). When price goes down from P1 to P2, firms decided to supply less by reduce output because sales was affected during recession. Contraction in output of firms leads to downsizing where firms lay off workers and reduce investment in order to reduce operating cost. This leads to decline in investments and rise in unemployment and decline in average disposable income. This leads to further decline in consumer spending thus dramatically fall in aggregate demand again. The cycle called the multiplier effect.

Figure 7: Negative output gap: Shift in Aggregate Demand

As consumption by households and businesses makes up about 71 percent of real GDP in US economy, the government must stop the recession from going deeper by intervening with expansionary fiscal policy (Taylor 2010). When government reduce taxes directly or indirectly, household spends more because their disposable income is higher after taxed. When government give investment tax credits to firms, firms are encourage to invest in capital. Either way, the AD curve shifts right. The same effect goes to increase in government spending. When government increase spending on building roads, transportations, education and healthcare, it creates jobs to the nations. As such, unemployment rate will fall, income will rise, people will spend more, businesses sales improve and expansion requires more capital and labour. The cycles in the long run will impact the potential GDP. As such, AD curve shift right. So, as shown in Figure 8, as AD increases, AD curve shifts from AD1 to AD2. Real GDP will increase from Y1 to Y2 and price level increase from P1 to P2. There is an inflationary gap. A higher price encourage higher wage rates, which will cause short run aggregate supply (SAS) curve to move leftward. As the SAS moves inward from SAS1 to SAS2, it intersects the AD2 curve, at higher price level, P3 and lower real GDP, Yfe (full employment equilibrium).

Figure 8: The effects of an increase in Aggregate Demand Government got to be cautious not to over stimulate the aggregate demand because it would cause inflationary gap. That is when AD curve shifts out beyond potential output level, labelled by LRAS curve, and leads by rising inflation caused by an inward shift of SRAS curve, price level at P3.

The stimulus package approved in 2008 and 2009 were good examples of fiscal policy. In 2008, President Bush passed the Economic Stimulus Act where most tax payers will enjoy a USD600 and USD1200 tax rebates each and those who got children, will get additional USD300 more per child. Besides individual benefits, businesses also get tax breaks when they invest in new plants and equipment. The stimulus package cost the USD168 billion (Associated Press 2008). In 2009, President Obama approved another largest multi billion dollars stimulus package since the Great Depression, with emphasis on providing financial aids to local and state governments, building infrastructure like highways, rail and healthcare, investments in energy and education sectors. It is expected to spur consumer spending, to save and create millions of jobs in two years time. Besides individual benefits, businesses were given investment tax relief and tax refunds for losses made with paid tax back in 2003, and tax credit for hiring (Meckler 2009). Figure 9 explains how expansionary fiscal policy mechanism impacts the aggregate demand in a simple flow chart.

Figure 9: Expansionary Fiscal Policy System

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3.11 Effectiveness of Fiscal Policy Besides short term effectiveness, it is important to assess the long term budgetary cost as well, given the worsening budget deficit situation in US. Without government intervention, the recession will recover eventually, but it could take years. With government stimulus package recession could recover faster. In recession, AD curve shifts left due to decline in total demand. Given the tax cuts and spending increase by government, the AD curve shifts right. If these countercyclical measures are timely enough and if it is of right magnitude, the recession would be short lived and small because such measure can offset the drop in demand and bring real GDP back to potential GDP. If the measures are implemented too late, at a point where the economy has already recovered, the excessive growth in total demand will probably leads to an increase in inflation. This happens because sometimes it takes years to implement a bill even though it was approved fast initially. This is a time lag issue. Besides, tax cuts do not always increase consumer spending because consumer might only spend some and save some of it. This is because they are sceptical and concern about future high taxes liability when government has to repay its debt borrowed to implement the stimulus package. US total federal debt level is about 95 percent of GDP (Figure 10). As such, people save more rather then spend it. The problem here is imperfect information constraints government ability to assess the value of multiplier effect thus might over boost the demand with its policy. And consumer uncertain reaction towards future tax liabilities dampens the purpose of stimulus. If these responses to increase government spending and tax cuts are late and not spontaneous, the stimulus package is deemed not effective. Besides its ineffectiveness, it enlarges government budget deficit and thus the risk in running into high debt to GDP level in the long run. US budget deficit is running at more than 10 percent of its GDP (Figure 11). Last but not least, massive government spending increase budget deficit which needs to be financed. High financing of government budget deficit means less private investment thus created crowding out effect on private sector. US total spending is running at about 44 percent of GDP (Figure 12)

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Figure 10: US Debt per GDP

Figure 11: US Budget Deficit

Figure 12: US Total Spending

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3.2 Monetary policy Monetary policy is used to influence the economy by varying money supply and interest rates to influence demand by Federal Reserve (Fed) the central bank of US. The greater the quantity of money, the greater is the level of aggregate demand. For simple illustration purposes, imagine Fed sends money to your mailbox. You would keep some and spend some so the demand for goods and services would increase. Changes in money supply will change the interest rate. If Fed increases money supply, the interest rate will fall. Conversely, when Fed reduces money supply, the interest rate will rise. So, a change in money supply affects aggregate demand through its impact on interest rate. When interest rate rises, households and firms will save more, spend less and borrow less. For example, household spend less on consumer goods and firms cut back on investment. This will reduce the aggregate demand. Fed reacted to the crisis by reduce interest rates and increase money supply. There are many ways to do this. The Fed can increase money supply by buying into government securities or by increase liquidity reserve ratios. The Fed can also introduce new ways to change money supply such as buying into private securities. The securities include short term commercial paper by financial and non financial firms, mortgage backed security (MBS), securities backed by student loans or credit cards, and security portfolio held by big insurance player AIG or investment bank Bear Sterns. Like in 2008, worrying Bear Stern falling will affect its creditor to fail together, thus jeopardizing the whole financial system and economy, Fed bought its assets. The same action applied to other failing firms like JP Morgan and AIG. In addition, to save the housing market from busting the Fed bought MBS hoping to reduce the mortgage interest rate. The purpose is to provide easy credit as it worried that lack of liquidity or credit in the financial market will harm the economy. So these actions taken were credit easing activities used to alleviate the financial crisis, which also means monetary easing. Another new way created is makes loan to others financial firms that are not banks like brokers, dealers, and insurance firms. The purpose is to save these firms from failing and thus create a domino effect through the economy. However, these old and new credit easing facilities will increase Fed reserves, thus resulting in increase of money supply in the market. Figure 14 shows the total assets of Federal Reserves balance sheet. It is evident the size has increased tremendously since the recession. Before recession, the size was about USD1 trillion. After recession, it shoots up to over USD2 trillion and is trending up.

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Figure 14: The Size of Feds Balance Sheet When reserves are raised, money supply will increase and interest rates will fall, inflation will rise (Figure 15). This is what happened when Fed makes open market purchase to change interest rates. When interest rate falls, spending will increase. By spending, we mean consumption, investment and net exports. As illustrated in previous section, the Fed has lowered the interest rate dramatically from 4.25 to 0 percent by increase money supply (Foley 2008).

Figure 15: Relationship between Interest Rate and Money Supply When interest rates is low, people will save less and consume more. So, consumption will increase in the long run. The relationship between interest rate and consumption looks like a demand curve. It shows the point where consumer is willing to consume at each price, where price is the interest rate. Consumer consumes less if price is higher and consume more when

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the price is low. Changes in price (in this case interest rate) leads to movement in quantity demanded, thus a movement along the consumer share line (Figure 16).

Figure 16: The consumption share and Interest Rate Any other factors that affect the consumption, the consumption line will shift to left or right. For example, an increase in taxes in consumption will reduce consumption because consumer has less money to spend after taxes. When this happened, the consumption line will shift to the left. Conversely a tax credit will shift the consumption line to the right. A similar relationship exists between interest rate and investment. When interest rate is reduced, the cost of borrowing is lower. So, businesses will invest in new machinery and equipments, build new building or factory. They need funds to finance such expansion. So, when the cost of borrowing is lower, firms tends to spend more by investing in more of these facilities. Conversely, when the interest rate is high, firms are unlikely to invest because the cost of borrowing is higher. To cover the higher cost, the firm needs to produce additional output to finance its debt. This means that firms will only borrow if they are very confident about their investment project success. That is why firms seldom expand during recession. Same goes to household investments. At lower interest rate, people will more likely to invest or buy houses because the cost of borrowing is cheaper, where people find its easy to repay their mortgage. Conversely, when interest rate is high, people buy fewer houses because the opportunity cost is higher. Rather than using their money to pay for higher mortgage, they can use it for their best alternative investment that generates higher returns. It is evident that high interest rate discourages investment and lower interest rate encourages investment in both firm and personal levels. This is shown in Figure 17.

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Figure 17: The investment share and Interest Rate. Other factors besides interest rate that affect investment will shift the investment share line. For example, an investment tax credit will encourage firms and household to invest more. So, the investment line will shift to the right. A change in firms expectations toward future would also shift the investment line. For example, if the firms feel that technology will lower their operating cost in future, it will invest on the equipment, thus increase investment at a given interest rate, and the investment line shift to the right. Conversely, if firms expectations are negative and full of pessimism, the investment would shift to the left. The same relationship goes between interest rate and net exports. When interest rate is low, net export will increase. To understand this, we first need to look at relationship between interest rate and exchange rate. When interest rate declines, and not elsewhere, the demand for US dollar by international investor will decline because they will move their funds to other non-dollar denominated assets in order to earn more in doing so. As international investors shift their funds out of US to London, Frankfurt, Tokyo and other financial centres to take advantage higher interest rate in these countries, the demand for US currency decline and puts downward pressure to the US currency or dollar exchange rate, meaning lesser units of foreign currency will be required to buy 1 USD in the foreign exchange market. When dollar exchange rate becomes weaker or lower, US import will become lower because imported goods are less attractive now as they are more expensive now. Conversely, the lower exchange rate increases US export to foreigners because it is cheaper and yet attractive to foreigners. When export increase and import decline, the net export will increase. As such, when interest rate decreases, dollar becomes weaker and exchange rate is lower, exports will increase and imports will decline. When net export is positive, there is a trade surplus. This relationship is shown in Figure 18.

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Figure 18: Net exports and Interest rate In nutshell, consumption, investment, and net exports are negatively related to interest rate. Investment, consumption, net export and government spending is the sum of real GDP and positively related to it. So, when interest rate increases, these components will decline, thus real GDP will decrease as well. Conversely, a lower real interest rate raises real GDP. When real GDP increase, so do aggregate demand. That is why during recession, Fed will lower interest rate to spur aggregate demand by stimulating consumption, investment and net exports. Figure 19 shows the entire flow how monetary policy affects aggregate demand and it summarizes above analysis into one simple diagram. In Panel A, we can see that increase money supply reduces interest rates. Panel B shows that lower interest rates encourage investment. This could be consumption also. Panel C shows that through the multiplier effect, the new autonomous investment increases income. Panel D shows that monetary policy increases aggregate demand by shifting the AD curve to right from ADo to AD1, stimulate and boost national output.

Figure 19: Monetary Policy System

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3.3 Supply side policy Aggregate supply is the sum of all goods and services can be produced b all firms in an economy. Supply side policy focuses on increasing the growth of potential GDP that is the aggregate supply by improving the factors of production such as labour, capital and technology. The improvement will further make firms operate in efficient manner and high productivity, without raising the inflation. Supply side policy has two sides mainly focus at product markets at one hand and labour market on the other hand. Product markets include all goods and services produced and sold to consumer. The goal is to increase competition and efficiency, so to improve firms productivity in the supply market. When the industry productivity improves, firms are able to produce more with lesser input. When the countrys productivity improves, unemployment reduces, and income per capita increase. This will improve nations living standard. The supply side policies for labour market focus on improving the supply of labour available in the market. Labour market got to be flexible so that matches between supply and demand of labour are easy and fast, thus lowering the risk of structural unemployment. Structural unemployment happened when people are jobless due to capital labour substitution or when there is a recession that created a decline of demand for labour for a long time like now in US. It continues to exist because layoff workers skills do not match with new requirements of new jobs. For example, retrenched workers by US car markers find it hard to be employed in other sector without being retrained and it takes time to re-train. This caused occupational immobility. This is part of the reason why US unemployment rate is so high since the recession took place and created a recessionary gap (Figure 20).

Figure 20: Unemployment Equilibrium (Recessionary Gap)

Figure 21: Full Employment Equilibrium

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Billions of dollars from the stimulus are granted to firms as investment tax credits. This will encourage firms to invest in plants and equipment so that firms could produce more at lower cost. Firms also get tax refund paid back in 2003 for losses made (Bendavid 2009). However, the stimulus intention emphasize on increasing aggregate demand then increasing supply because during recession period, firms have lots of excess capacity and more than happy to supply at any price. Firms are happy if they can sell more and often eager to offer promotion or sales to clear inventory. Besides, supply side policy by itself is not effective. To be effective, there must be enough demand to take up the supply produced. That is why the fiscal stimulus tailored by the government emphasizes improving demand rather than supply so that real GDP could move back to potential GDP (Figure 21). Here is the logic. Now, to generate that demand, household must spend and business must invest. To have money to spend and to invest, both must have income and profit. To have income, people needs to be employed, hence government must reduce unemployment. To reduce unemployment during recession, government must create jobs to the unemployed. Business would profit only if household spends. That is why big chunk of the stimulus package of 2009 emphasized on spending over tax cuts as it is the quickest way to create jobs. From the spending portion, a big chunk is dedicated to build infrastructure like bridge and road, high speed rail investment, public transportation improvements, and more because these projects will create millions of jobs in the market instantly. Besides, subsidies in the form of financial aid or jobless benefits are another type of supply side policy given to the unemployed to boost demand. The golden question is with such aids, benefits and credits, would household spend or save?

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3.4 External policy Figure 22 shows how exchange rate policy affects aggregate demand through the impact from expansionary monetary policy. Panel (a) shows economy experience unemployment equilibrium state (recessionary gap) and attempt to close the gap by stimulating the aggregate demand by shifting it to AD2. Panel (b) shows Fed purchase bonds resulting in increase demand for bonds and thus raise the bond price. Panel (c) shows the purchase of bonds by Fed increases the money supply in the market and that reduce the interest rates. Panel (d) shows that demand for US dollar decline when interest rate falls because dollar assets are less attractive. Consequently, the increase in supply of US dollar lowers the value of US dollar. The lower dollar value makes exports cheaper to foreigners and imports more expensive to Americans. This will stimulate the domestic consumption and investment, thus the domestic economy. It also improves net exports. Collectively, it shifts the aggregate demand (AD) curve in Panel (a).

Figure 22: Monetary - Exchange Rate to close recessionary gap The impact is even greater when the interest rate hits zero percent during the recession. The dollar value continues to decline, further stimulating the economy further by rise in exports and decline in imports. However, if the global economy already in recession, depreciation of dollar only worsen the recession in those countries by reducing the countrys exports. As US follows flexible exchange rate system, the dollar will fluctuate based on demand and supply of dollar.

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Figure 23 shows how exchange rate affects aggregate demand through the effects of expansionary fiscal policy. Panel (a) shows government finance spending by selling more bonds, thus resulting in lower price of bonds and higher interest rate. Panel (b) shows that higher interest rates makes US dollar more attractive. As such the increase demand for US dollar reduces the supply thus resulting making the US dollar appreciates. The stronger dollar makes exports expensive and import cheaper, thus resulting decline in net exports. Panel (c) shows that increase in government spending shift the AD curve out to AD2 if there are not unfavourable impact on other components of AD such as investment and net exports. Unfortunately, the fall in investment and net exports portion offset the AD increase to AD2, resulting it to shift back to AD3, created crowding out effect. Such effect reduced the success of the policy.

Figure 23: Fiscal Policy and Exchange Rate

Based on above analysis, even though both policies were meant to stimulate aggregate demand, fiscal policy reduces its own effectiveness by crowding out effect and overall effectiveness of monetary policy.

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4.0 Success Rate Since the recession started in end 2007, the US economy has lost millions of jobs and real GDP has dropped significantly (Figure 24). Based on the latest report from US Department of Labour, there are 14.8 million unemployed people (BLS 2010). The question here is whether all these policies are effective in recovering US recession? Can a dollar spend by the government leads to a dollar more or less to GDP? Will the multibillion dollar stimulus package stimulate the economy or just a waste of resources?

Figure 24: US GDP Growth Rate It has been a long time great debate on whether fiscal stimulus was the right way to handle recession or monetary policy is fit. Since the Great Depression, anti-stimulus economist claimed government intervention did not work as the depression took long time before is recovers after stimulus applied. Conversely, stimulus supported economist rebuff with the reason being the stimulus amount was just not great enough. Now, lets look at some facts here. Even though Fed Chairman Ben Bernanke has gone all out to battle recession by taking extraordinary move to reduce interest rates to basically zero percent with the aim to provide easy credit to everyone especially the housing market, the economy continues to weaken. Together with Obamas fiscal stimulus, he expected the approach would generate economy recovery by late 2009 and would foresee uninvited inflation in 2010 (Coy 2008). Unfortunately, the actual results seen now are not what the policy makers expected. Today, the US economy is still in the slump and there are trillions dollars of monetary excess in the banks in US but no one would borrow it. There are no lending activities. How could there be economic growth if there is no capital lending or borrowing. The inflation rate is at record low. The economy does not face liquidity issues but other problems like solvency, weak housing

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market, and depressing firms and high unemployment rate. I believe monetary easing is not going to improve any thing. Furthermore, the unemployment rate has risen dramatically after the crisis in 2007 and peaked at 2009 and is still high now (Figure 22). This shows that the multibillions of dollars of stimulus packages by government and the monetary policies intervention by Fed has little impact in improving the labour market in US. In my opinion, the monetary policy has failed and the fiscal policy has failed in reviving the recession.

Figure 22: US Unemployment Rate Still High

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5.0 Future Policy for US Economy The biggest problem with US economy now is the negative expectations and shattered confidence level of the nations. The weak economic growth since recession and record high unemployment rate has tumbled, intimidated and wrecked the nations confidence level dramatically. Everyday people are surrounded with bad news focusing on the negative aspects of the recession and the curse of burden of government debt to the future generation. Technically, the economy is out of recession after 18 months and being the longest duration of recession after Great Depression (Matthews 2010) but emotionally I believe they are still in recession. If the economic variables continue to weaken or shows no improvements, besides further worsening the nations expectations, there could be correction in the stock market when companies results or performance continue to go south or demonstrate unsustainable behaviour. Higher volatility in sustaining firms earnings and profit would lead to investor to be cautious and make them to be risk averse. Collectively, this will lead to economic shock. In addition, developed nations have started to implement austerity measures to reduce budget deficit by lowering government spending and increase taxes (Stein & Wesbury 2010). These actions had further dampened consumer and businesses confidence and also discourage household spending. Household and business saves more for future that is full of uncertainty, thus limiting their spending which accounted the biggest part of income for the US economy. Decline in household spending will affect firms business. For example, due to austerity measures and weak consumer confidence in developed countries, Heineken, the world third largest brewer, sees it revenue affected and declined (Fletcher 2010). Expectations of all perspective of future economic climate and conditions play an important role in reviving the US economy. The expectations include future deflation, future incomes and future profits. Such expectations are powerful, contagious and slow down recovery. For example, the economy continues to stay depressed if the people expects that way, resulting an expectation trap. So, to improve the household and business confident and expectation, the government should look into how to improve country high unemployment rate. The Obama administration or the new house who take over from him if he lost in the next election should consider salary tax cuts for few years for massive low to medium income earner who earns less than a certain income threshold and to impose higher income tax to higher income earner who earns high income threshold.

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In this way, the fiscal cost involve in implementing such plans could be made revenue neutral. The reason to make it revenue neutral is because we do not want to further enlarge the current budget deficit which is already at high level. By doing so, we would not risking future consumption of private sector which also supports the economy growth. Therefore, the new policy forward has to be revenue neutral should not increase budget deficit and must stimulate the demand for labour. This is what the US economy must have now in order to recover from recession because no jobs mean no income to household and limited sales to businesses. Lack of those two means household has limited money to spend and business has limited capital for investment. Imagine no more jobless benefits from the government. How would you pay your utility bills, rental, car loan, credit card debt, and house mortgage? If households and businesses do not spend, there will not be economic growth.

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6.0 References

1. Economic Stimulus Package (2008) President Signs Economic Stimulus Act of

2008 With Rebates And Business Incentives Feb 13 < http://tax.cchgroup.com/legislation/2008-stimulus-package.pdf>

2. Anonymous (2010) High possibility of another recession in the US, says economist
September 28, TheStar < http://biz.thestar.com.my/news/story.asp? file=/2010/9/28/business/7114395&sec=business>

3. Associated Press (2008) Bush signs stimulus package into law: Rebates of $300 to
$1,200 go out beginning in May February 13 2008 Associated Press < http://www.msnbc.msn.com/id/23143814/#>

4. Bendavid N (2009) Stimulus Package Unveiled January 29, The Wall Street Journal
< http://online.wsj.com/article/SB123202946622485595.html> 5. BLS (2010) Consumer Price Index September 2010 October 15 2010 Bureau of Labour Statistics, US Department of Labour 6. BLS (2010) Mass Layoffs-September 2010 October 22 2010 Bureau of Labour Statistics, US Department of Labour

7. BLS (2010) THE EMPLOYMENT SITUATION OCTOBER 2010 November 5

Bureau of Labour Statistics http://www.bls.gov/news.release/pdf/empsit.pdf

8. Calmes J & Hulse C (2009) Obama Considers Major Expansion in Aid to Jobless
January 3, The New York Times < http://www.nytimes.com/2009/01/04/us/politics/04stimulus.html? pagewanted=1&_r=1&em>

9. Clementine Fletcher (2010) Heineken Revenue Misses Estimates, Hurt by Austerity

October 27 Bloomberg < http://www.businessweek.com/news/2010-10-27/heinekenrevenue-misses-estimates-hurt-by-austerity.html>

10. Colvin G (2010) Cut or spend out of recession: Whos right? November 2, Fortune <
http://finance.yahoo.com/news/Cut-or-spend-out-of-a-hftn-2030075559.html?x=0>

11. Coy P (2008) The Fed's Fierce Battle Plan December 2008, Bloomberg
Businessweek < http://www.businessweek.com/magazine/content/08_52/b4114022505333.htm>

12. Economic Report 2007/2008 <

http://www.treasury.gov.my/pdf/economy/er/0708/chapter1.pdf>

13. Foley S (2008) US slashes interest rates to new zero-0.25% range December 17,
The Independent < http://www.independent.co.uk/news/business/news/us-slashesinterest-rates-to-new-zero025-range-1193026.html>

14. FRS() Monetary Policy Oct 26 2010, Board of Governors of the Federal Reserve
System http://www.federalreserve.gov/monetarypolicy/bst.htm

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15. Gore M (2009) Obama $300 Billion 2009 Tax Cut and Incentives: Economic Stimulus Plan Cost to More Than Double in Two Years January 6

16. Gott L (2009) 2009 Economic Stimulus Package Obama's Plan February 3,
American Recovery and Reinvestment Act < http://www.suite101.com/content/2009economic-stimulus-package-obamas-plan-a93813>

17. Herbst M (2009) A Red-Letter Day for Layoffs January 27 Bloomberg Businessweek
< http://www.businessweek.com/bwdaily/dnflash/content/jan2009/db20090126_735128. htm>

18. Herbst M (2009) Stimulus: How Porky Is It? February 3 Bloomberg Businessweek <
http://bx.businessweek.com/obamas-stimulus-plan/view?url=http%3A%2F %2Fwww.businessweek.com%2Fbwdaily%2Fdnflash%2Fcontent %2Ffeb2009%2Fdb2009022_179449.htm>

19. Kaiser E (2009) The U.S. recession will probably be the longest since World War
Two and could worsen without heavy government spending, according to a closelywatched survey of economists released on Saturday. January 10 Reuters http://www.reuters.com/article/idUSTRE5090QL20090110

20. Keating JE (2010) What shape is your recession? November Foreign Policy
Magazine < http://www.foreignpolicy.com/articles/2010/10/11/what_shape_is_your_recession? page=full>

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