Business Cycles and Economic Outlook 3 pages

 

It is not so easy to define recession as there is no universally agreed definition of recession. The common definition of recession that is often used by newspapers will suggest that recession is a period of general economic decline that causes and results in decline in the Gross Domestic Product of a country for two or more consecutive economic quarters of a financial year.

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The typical associated consequences of recession are a drop in the stock market graph, an increase in unemployment rate and a decline in realty sector. Yet, the definition does not emphasize on any such consequences and hence it cannot be termed as a universal definition of recession. Furthermore, with this definition of recession that depends on two quarters of financial year, it is very difficult to mention the exact point of time of the beginning of recession. That is, recession remains a mystery.

Right since January 2008, non-financial companies and individuals were experiencing liquidity crunch and that resulted in job cuts. By September 2008, the average job loss of USA for the eight months was 81,900 job cuts per month, during the last four months, it was 483,500 per month. With job losses, consumer spending fell by 3.8% in the three quarters of 2008 and in fourth quarter it fell by 36% below the final quarter of 2007.The National Bureau of Economic Research’s Business Cycle Dating Committee declared that the U.S. economy is in recession since January 2008 (Strauss; Engel, 2009).

According to the media pundits and mainstream economists, the cause of a recession is the tight money policies and raised interest rates by the Central government that results in liquidity crunch and causes job cuts, declining consumer spending and hence a recession (Cochran, 2001). They thus support that stimulating the economy with easy money, governmental loans, huge stimulus packages and lowering interest rates may help the economy in bringing the boom again. The idea suggests that the Market cycles of Boom and Burst originates from the central bank action of expanding the money flow in the market and contracting it. The idea is absolutely flawed and this can be easily seen with the failure of the economic stimulus given by the Bush government and supported by the new government of Obama.

It should be clear that a burst or a recession occurs because there was a boom in market. A boom obviously is the period when an economic sector is unnecessarily provided easy loans, higher profits and more support by the authorities and central government to cause high rise in prices that creates a false demand in the market and causes inflation. That is, the downturn, or the depression or the recession is exactly because of the Central bank, not because it started tightening the financial sources, rather it is because of mal-investment initiated by previously created credit resulting from central bank (Cochran, 2001).

Mainstream economists also suggest that the market will recover and the prices will inflate again if further easy money is provided through government spending, ridiculously huge stimulus packages and other similar tactics. They believe that by doing so, the stock market will again start rising high. Yet, with all economic stimulus provided, stocks as a broad group are down since last ten years (Browning, 2009). That is, economic stimulus and credit policies of Central bank failed since last 10 years.

It is also important to understand the reason of liquidity crunch. A liquidity crunch occurs only when the present amount of money in the market, which is nothing but a means of exchange, is mal-invested in those sectors that are facing false demand or boom. Since the money was mal-invested in supplying the false demand, it gets trapped. Lenders don’t get their loan back and they suffer liquidity crunch. Thus, the reason of a recession is the easy credit policies by the government and central bank that causes Boom in the market. When the wrong policies of the government and central bank fail, the market suffers recession.

Thus, recession can be defined as a cure to the ill-policies of government and central bank that caused boom in certain sectors such as housing market. Because of that boom, easy credit policies, subsidies, easy lending and many other government and central bank caused factors, the prices soars to extreme high and causes inflation and money gets trapped in mal-investment. As the recession acts as a cure to this situation of extreme falsehood, it starts decreasing the extent of false demand and tries to bring the market to its actual true situation. The prices start declining and the economy starts recuperating from the illness of false heights.

Since recession itself is the cure of problems of mal-investment that were caused by the government and central bank’s ill easy money and credit policies, it cannot be cured by further stimulus. The stimulus will only sustain the recession for longer periods until all the mal-investment is not neutralized and the economy comes in a situation to achieve sustainable growth (Cochran, 2001). The idea can also be substantiated with the expectations of Housing economists who expect that over the next 10 or 20 years, the prices in realty sector may start rising again on an average, but that rise won’t be as much as the average rise was during the past decade (Hagerty, 2008).

Obviously, because of easy money and mislead credit policies caused a boom in housing market and created a false demand that consequently resulted in unsustainable boom. As a neutralizing phenomenon, the market forces caused liquidity crunch to cure the mal-investment. Until the mal-investment will not neutralize, market will not gain sustainable growth. Stimulus package can only delay the time for achieving the sustainable growth. The stimulus also failed to provide any help in improving the job market, the unemployment rate is still 9.7% in the month of May 2010 (Trading Economics, 2010), while it was 6.9% in 2008 (Strauss, 2009). Now with the problems of liquidity crunch still persisting, even the retirees are looking forward to find jobs (Greene, 2009). The situation shows that expensive stimulus may also push U.S. towards the same fate that the Greece government and public are suffering right now.

Robert Lucas supported the idea of Ben Bernanke to reduce the interest rates (Lucas, 2008). Every sane minded person will support the idea. In fact, the government or the central bank should not have the power to decide or dictate the interest rates. Interest rates should be decided by the free market proponents freely as per the time requires and permits. Yet, till how long will the central bank and government let the market enjoy the falsehood of stability on the basis of stimulus, what will happen when the central bank and Obama administration will look forward to take the stimulus back? Only then the market will again step forward towards curing the mal-investment caused by bad credit policies and only after that cure the market will be in a position to attain a sustainable growth.

References

Browning, E.S. (2009), “After the Collapse, Guarded Hope for ’09,” the Wall Street

Journal, January 2, Retrieved 22 June, 2010 from:

http://online.wsj.com/article/SB123084159289047143.html

Cochran, John P. (2001), “Austrian Business Cycles, Plucking Models, and Real

Business Cycles,” Austrian Scholar Conference, Auburn, Alabama. Retrieved 22 June, 2010 from: http://mises.org/journals/scholar/Cochran.pdf

Greene, Kelly. (2009), “There Goes Retirement,” the Wall Street Journal, March 1,

Retrieved 22 June, 2010 from:

http://online.wsj.com/article/SB123421515383065059.html

Hagerty, James R. (2008), “The Future of Home Prices,” the Wall Street Journal,

December 2, Retrieved 22 June, 2010 from:

http://online.wsj.com/article/SB122764977315457619.html

Lucas, Robert E. (2008), “Bernanke is the Best Stimulus Right Now,” the Wall Street

Journal, December 23, Retrieved 22 June, 2010 from:

http://online.wsj.com/article/SB122999959052129273.html

Strauss, W. a; E. Engel (2009), “Economic Outlook Symposium: Summary of 2008

results and forecasts for 2009,” Chicago Fed Letter, Federal Reserve Bank of Chicago, August. Retrieved 22 June, 2010 from:

http://www.chicagofed.org/publications/fedletter/cflfebruary2009_259.pdf

Trading Economics. (2010), “United States Unemployment Rate,” May, Retrieved 22

June, 2010 from:

http://www.tradingeconomics.com/Economics/Unemployment-Rate.aspx?Symbol=USD


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