Introduction

According to Barnes (2008: 1) the global financial crisis was caused by wasteful lending that led to Losses; the crisis started in the United States of America as the federal reserve bank started cutting down interest rates in 2001 to increases money supply which, via the multiplier effect, would stimulate the economy (New Geography, 200: 1). With the low interest rates there was a greater availability of mortgage funding, which predictably led to greater demand for houses as subprime borrowers qualified for loans far larger than they could have secured in the past (New Geography, 2008: 1)). Broadly speaking, when the borrowers failed to meet their debt obligations banks started to fail which had spill over effects to the rest of the global economy. According to Carmody and Hampwaye (2010: 87) in African countries, like Zambia, which is rich in mineral resources (copper), are better off since they receive great amounts of foreign investment. Carmody and Hampwaye (2010: 96) also states that African nations have been affected in two channels by the crisis: financial (flows into stock markets, bank lending, and foreign direct investment) and real (remittances, import and export volumes, terms of trade, and aid). Oil exporters and other monoeconomies, such as Zambia, which is dependent on one commodity that saw dramatic reductions in price, was gravely affected by the crisis (Carmody and Hampwaye, 2010: 96). A lack of funding can hold back a recovery by limiting timely responses by government in uncertain economic conditions (AUC, 2009: 3). This paper is to prove this fact and how policy measures are implemented to offset a recovery in the midst of recessionary conditions.

Body

A number of countries in Africa have implemented cuts in the interest rates; for instance the Central bank of Botswana cut the interest rate by 50 basis points in December 2008; while that of Nigeria cut the rate by 10 basis points (AUC, 2009: 9). The rationale for cutting the interest rate is to decrease the cost of borrowing money to, ultimately, finance investment projects, thus stimulating the economy.

Some countries have taken a more direct approach into increasing the liquidity of their banking system; such as in Cote dIvoire, Togo and Mali amongst others in which the common central bank injcts money to the regionalmoney market weekly (AUC, 2009: 10). Figure 1 below shows the effects of an increase in money supply, liquidity injection, in the economy. Initially we have LM0 and IS0 intersecting at the equilibrium point A at an interest rate of r0 and national income y0. When the money supply is increased by the central bank, the LM schedule shifts rightward to LM1 (Froyen, 2009: 137). At the initial interest rate, r0, and the new LM1 schedule the money supplied exceeds money demand (Froyen, 2009: 136). Hence people start to save their money through buying bonds, causing the price of bonds to increases and the interest rate goes down (r0 r1) (Froyen, 2009: 137). Investment increases as the interest rate goes down (Froyen, 2008: 137). With an increase in investment, national income increases both as a result of increased investment and an increase consumption via the multiplier effect (Froyen, 2009: 137). Income will increase and money demand will increase until money demanded equilibrates money supply at point B (Froyen, 2009: 137). The effectiveness of expansionary monetary policy depends on the slope of the LM curve, and the flatter the IS curve (the more interest elastic) the more effective is monetary policy (Froyen, 2009: 145). The opposite would happen if the central bank decided to contract the supply of money.

Figure 1:

An increase in Money Supply

While some governments have elected to curb their spending, such as Greece, some have implemented fiscal stimulus packages (AUC, 2009: 10). The stimulus packages are intended at boosting economic growth and to mitigate the effects of the crisis. The Egyptian government announced a fiscal stimulus package valued at 15 billion Egyptian Pounds, while Cape Verde has raised public spending by 17% (AUC, 2009: 10).

Using our IS-LM model we explore the effects of a fiscal stimulus package, an increase in government spending. In figure 2, the initial LM and IS (I + G0) curves intersect at point A where income is y0 and the interest rate is r0. When government spending increases the IS(I + G0) curve shifts rightward to IS( I + G1), therefore increasing money demand (Froyen 2009: 138). Individuals start to sell bonds to increase their liquidity preferences and thus the interest rate begins to rise (r0 r1) as the price of bonds falls (Froyen, 2009: 138). As the interest rate rises investment decreases as it is now expensive to borrow money. When

investment declines so does income from y1 to y2, forming a new equilibrium at point E1 (Froyen 2009: 139). Overall income and interest increases as government expenditures increase (Froyen, 2009: 139). A tax cut would have the same effects on the IS curve but with reduced policy multipliers (Froyen, 2009: 139).

Figure 2:

Effects of an Increase in Government Expenditures/ Tax Cut

In figure 3, a tax cut from T0 to T1 would shift the IS schedule to the right [IS(T0) IS(T1)]. When a tax reduction is accompanied by expansionary monetary policy from M0 to M1, the LM schedule would shift to the right [LM(M0) LM(M1)]. Together the two policy responses would raise income (y0 y1) but maintain the interest rate at r0.

Effects of simultaneous use of Monetary and Fiscal policy

As demonstrated a rise in government expenditures can increase national income, boost the economy, yet some countries have implemented fiscal restraint. This is due to fear of out-ofcontrol government debt and its resultant effects. However such measures could be detrimental to the economy as a decrease in government spending has opposite effects of those discussed earlier.

Other policy measures which have been implemented in other countries include trading policy measures as was seen in Cameroon where import taxes on capital goods where cut and Central Bank of Madagascar has devalued the domestic currency in order to re-establish the competitiveness of its imports (AUC, 2009: 11).

Conclusion

Third world economies are merging to form a pillar of strength for African and Asian nations being shocked by absurd economic policies (risky lending to subprime borrowers) put into place by industrialised nations. Governments are cooperating in creating long lasting effects of action designed to curb unemployment and unprecedented shocks in their markets by increasing the diversity of their export portfolios. The crisis may serve to reorient African economies further toward the countries of East and South Asia (AUC, 2009 11). In Africa oil-exporting countries in the region have more fiscal power to conduct sound responses in policy because they have large foreign reserves saved during the recent oil price hikes (AUC, 2009: 9). In the non-oil economies, however, the ability to adopt effective fiscal policies is severely hampered and so the use of fiscal stimulus measures is not widespread in these poverty stricken economies (AUC, 9: 2009).