Tuesday, October 7, 2008

Can A Recession Be Avoided?

Readers Question: Can A Recession Be Avoided?

No,With the UK already having stagnating growth, it is almost inevitable the economy will decline in the last quarter of this year and early in next year. The big question is: How long will the recession last? How deep will the recession be?

To reduce the impact of the recession the Government and Monetary authorities can try:
  1. Cutting Interest Rates (monetary policy) to try and boost spending and investment
  2. Cut income tax and / or increase government spending (fiscal policy) to try and increase Aggregate Demand
  3. Ensure stability in banking system and financial system and overcome worst impact of credit crunch on lending and housing market
The credit crunch and banking problems is a major factor in contributing to the present recession. However, 'creating stability in the banking system' is easier said than done. No one is quite sure how much or what kind of government intervention is required. There is also the danger that government intervention might not improve things but just reinforce the bad decisions made by the banks.

Cutting interest rates should help alleviate problems like mortgage defaults and it may encourage spending and investment. However, as I say in the video; I fear there is a danger people may be slow to respond to interest rate cuts in the current climate.
Expansionary fiscal policy can also help. I believe increased government spending would be more helpful that tax cuts. But, with government borrowing already high, this policy is limited.

The experience of Japan, gives little grounds for optimism. With falling asset prices, Japan tried everything to boost economic activity. 0% interest rates, expansionary fiscal policy (I think Japan's National debt is over 150% of GDP) but struggled for many years to get out of a deflationary spiral. I think we can avoid this. But, quite soon, this crisis may cause textbooks to have substantial rewrites.

See also: Video on Causes of Recession

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