Friday, September 23, 2011

Policies to Avoid Recession

Depressingly soon after the great recession of 2009, global economies look to be entering another recession. If we are not technically in a recession, it already feels like it.

Are there any policies which can avoid recession?

David Cameron recently wrote a letter to the leader of the G20 talking about the necessity of improving global economic growth. It was a little vague as to how this economic recovery would occur. He mentions 'tackling key problems' and criticised US and EU for not doing enough to confront the debt overhang to prevent a wider contagion to the wider global economy. Unfortunately, this prognosis offered by Cameron does little to 'restore confidence'. The UK is a good example of how an economic recovery has been sniffed out because the government placed too much importance on short term fiscal austerity at the wrong time. We are not really in a position to preach about the virtues of boosting economic growth.

To imagine the world economy can be fixed by concerted efforts to reduce government spending and reduce government debt is not the case. Yet, politicians seem to have a habit of equating debt with recession as if they are the same thing.

Austerity measures have dampened confidence. They have cause a rise in unemployment and the private sector hasn't taken the place of the government. It may be surprising to some. But, if you depress the population by repeatedly talking about austerity, job cuts and spending cuts, it is almost inevitable.

The UK and US have more options than the Euro members because they don't have the problems of liquidity fears which seem to paralyse Euro bond markets / single monetary policy / floating exchange rate.

It is interesting that the crisis has caused the yield on US treasury bonds to fall to the lowest level since the 1940s. This means investors want to buy US government bonds. It suggests markets fear a recession much more than a US government default

Policies to Avoid Recession

Fiscal Policy

Short Term stimulus / Long Term Structural change.

The government should boost spending. They should take advantage of the low bond yields. This increase in discretionary fiscal stimulus will
  • Boost Aggregate Demand
  • Create jobs
  • Improve business and consumer confidence.

At the same time, the government should set out concrete plan to deal with long term spending commitments. It should make decisions which reduce long term entitlement spending.
  • e.g. raise retirement age
  • Evaluation of health care spending -
  • Caps on cost of health care
  • Increase taxes (delayed till after recession)
Here Cameron is right that there needs to be a strong political will to do the right thing. I doubt the US has this political will to agree on either short term stimulus or long term fiscal consolidation.

This combination of long term structural changes will reassure markets about debt. The short term fiscal stimulus will reassure markets, the government is committed to increasing GDP.

Governments need to understand economic growth is a KEY factor in reducing debt/ GDP ratios. You will never get to grips with a debt crisis if you plunge your economy into a recession.

Monetary Stimulus.

Federal Reserve's Operation Twist. This is a move in the right direction. Buying long dated mortgage bonds, helps to keep mortgage interest rates low and can help boost spending / investment. Markets fear it is too little too late. The Federal Reserve may need more quantitative easing to provide monetary stimulus.

Quantitative Easing. Creating money electronically and buying long term securities can have a role in increasing money supply and economic growth.

Higher Inflation Target Now is not the time to worry about inflation. Headline CPI is misleading because it includes temporary cost push factors. The Monetary authorities should be targeting 'core inflation'. This may in practise mean a CPI rate of over 2%. But, that is not the problem. Otherwise in 2012, we could see a period of deflation which would be disastrous for the economy.

Lower Interest Rates

The ECB should reverse its decision to raise interest rates earlier in the year. Only the ECB would increase interest rates as the world economy was heading into a double dip recession. When will the ECB realise there are worse things than a temporary blip in cost push inflation?
However, an interest rate cut of 0.5% would only have a limited effect in boosting EU growth. Much more is needed, but at least it would be a signal they are interested in boosting growth.



Anonymous said...

If only it wasn't Keynes saying that stimulus to compensate aggregate demand is only really effective in relatively closed economies, that is to say with tariff barriers and minimal trade. But currently in practice with free capital flows and globalization pretty much most of the stimulus has been in fact relatively ineffective. The multiplier has been small - indeed negligible - and the stimulus have been therefor rather poor. In terms of strict Keynesism these policies can hardly be justified. So I don't think the answer lies in yet more Keynesism, anymore than it necessarily lies in printing yet more money. In fact Bernanke's 'Operation Twist' has already been proved ineffective in the 60's. So all considering, why should be we expect any different now.

There is a fairly large group who have stretched Keynes ideas out of it's context, these economist are like generals fighting the last war.

They are fighting the last depression, as if these problems are the problems of the 1930's and these are not the problems of 1930's. Our problems are very distinctive. We started with excessive public debt in many western countries and adding a new layer of public debt has not solved the problems, indeed it made it worse in countries like Greece, Portugal and Ireland. We need to look the the structural causes of the underperformance of western economies right now. And we have to bear in mind that the one reason the economic growth is sluggish is not just that there is a lack of aggregate demand, there are two other major problems. One is the problem of uncertainty and lack of confidence in the business community, which is stopping cash rich firms from investing. The other is the serious competition from the Asian end of the world and that competition makes it very hard to indeed to create jobs for relatively unskilled western workers. So our problem seems to be more structural than is generally recognized by the economics profession, which generally speaking prefers to focus on fiscal monetary stimulus as the solution to nearly every problem.

David said...

How about encouraging a recession and getting out of debt ? It's going to happen one way or another.

Barak said...

the only policy to avoid recession, is creating jobs.

The only solution to avoid recession is real work, which stimulates jobs, and stimulates the economy.

The western world, revolves around consuming instead of manufacturing , and creating work.

printing money is not the solution to recession.

Look at what China does...

you can read my blog about these ideas at: