Sunday, February 17, 2008

Recession is good? [draft]

Recession is like a Cold--Not Good, Maybe Inevitable

Articles such as Will the Cure be Worse than the Disease? by Shawn Tully asks the question whether a recession is necessarily a bad thing. He suggests that the cure such as temporary stimulus package and interest rate cuts are worse than a recession. Currently, the economy isn’t terrible, although it is uncertain. The Fed is not predicting one for 2008, but it is possible.[1] The article points out that Bernanke is acting as though a recession must be avoided at all costs, which many on Wall Street are happy to hear, but Shawn Tully thinks this will create a bigger recession down the road by pointing to how the low rates of early 2000s created the housing bubble that led to the credit problems that we are dealing with now. Mr. Tully’s advice is to stop the repeat of 1970s by holding the Fed funds rate steady and if a recession occurs, so be it.

Although I understand and appreciate many of his sound points, in addition to the fact that Bernanke might even have a personal agenda to save the economy as his position is dependent on how “well” he handles this peril, I still don’t think a recession is good thing. Most people that lived in the economic conditions of the 1970s when there was stagflation would choose not to suffer through that again. As soon-to-be entrant into the workforce, I hope to not have to face this recession.

Some economists believe that a recession will act as a useful resetting process. But didn’t the 2001 recession lead to recessions in many parts of the world? Also in trying to cure that recession, a housing bubble emerged and led to the sub-prime crisis, which rippled across the globe. Recessions consists of massive job loss, shortages, and political instability. They are also dangerous because they can lead to bad policy and poor moral judgment.[2] For example, the Smoot-Hawley trade tariff at the beginning of the 1930s and John Major's regrettable commitment to the European Exchange Rate Mechanism during the early 1990s. When a recession hits, will we relegate environmentally friendly initiatives and corporate responsibility? Recessions can also lead to higher levels of crime, substance abuse, and deprivation.

The reason why a recession can be good is that if it can reduce the severity of future recessions or provide stability in the future. Economist Allan Meltzer says, “It’s better to take a small recession and kill inflation immediately instead of facing high inflation and a really big recession later.” His evidence is the 1970s when oil prices created double-digit inflation, which took until the 1980s and an unemployment of 11% to finally curb. In essence, it is better to lose fifty dollars today than to lose your job in a year.

However, I am not sure that this is possible because we cannot predict future events and can’t just say, “look we’ve just suffered through a recession. We should be good for five years now.” I don’t think we can save up recession credits by allowing recessions to happen. It’s almost like trying to catch a cold now to prevent a cold later. It’s an unpredictable method. Who knows how long before you catch your next cold, and who knows how bad it’ll be? Just eat in moderation and exercise daily. In monetary policy terms, don’t indulge in excess.

Yet the truth is recessions and booms are terribly difficult to predict, and even more so to control. Who could have predicted when we would discover something as revolutionary as the printing press, assembly line, electricity, or the internet? Who could understand the internet or its limits in 1999? And who knows when we will discover the next revolutionary spark that will change our lives, spur growth, and create another big boom in the economy? Leading economists and policy-makers try to implement inflation targeting policies so when they think booms are occurring, they tighten the money supply, and when a recession threatens, they ease the money supply. They are trying to minimize the business cycle, keep our growth rate steady, and stabilize inflation.

At this time, we do not have the ability to control the business cycle very well so a recession every now and then is necessary. Recessions can be regarded as the result of earlier excess.2 If we want to stop recessions, we need to reduce the excesses, but innovation like punctuated equilibrium isn’t a fixed and steady growth path. Unless we can find a way to make growth steady, we will have to put up with recessions which are simply economic adjustments, an inevitable feature of market economies.

I understand why the Fed is doing everything possible to avoid a recession and how vital it is to do so. Once we realize the risks of a recession, we will never take going into a recession lightly or think it’s a good thing. When the US economy is shaky, the world economy is unsteady because the US economy is such a force in the global economy and the world is more interdependent than ever. I believe the Fed is doing the right thing because if the US falls into a recession, it may take the world with it. With more at stake than just the US economy and its inflation-related concerns, governments and other stakeholders now are doing their best to prevent a global economic slowdown that can last for years because of worldwide amplification and momentum effects.

In a country: Once consumer confidence goes down, spending is reduced, and once spending is restrained, products don’t sell and production idles. This means layoffs which takes money out of the economy and reduces consumer spending and confidence even more. It’s cyclical in itself, but when the country engages in trade: The country reduces imports, which means fewer exports for another country which reduces the exporter’s output, GDP, and income. With less income the exporter buys less which reduces its trading partners’ incomes.

This spreads like a virus from one country to the next. A viral, downward spiral is initiated and it will be tragically difficult to reverse if the whole world has caught the disease. No country can bail another country out. Investors still remember the Asian Financial Crisis which involved America bailing out many emerging economies. Now it’s their turn to bail out the largest economy in the world while they still can. Similar to the money multiplier in which a single dollar’s overall effect is greater than itself, a small recession can quickly be magnified and it can take a very long time to reverse. Once there is a selling off mentality on the stock market and economy, it is likely to continue due to self-fulfilling prophecy; thus I would never advise a voluntary recession. It will take an extraordinary event to reverse a recession and when that will happen is hard to predict.

In addition, America may already be in a recession. An AP article by Jeannine Aversa titled Many Believe US Already in a Recession points to many indicators that argue America is already in a recession. BusinessWeek’s Recession Watch reveals Jan Hatzius, senior economist at Goldman Sachs believes "There is no longer much doubt in my mind that the U.S. economy is now in recession”.[3] The business cycle changes and the nature of a recession also changes, so maybe America is already in one. Given how hard it is to agree on whether America is in a recession or not, it is best to play it safe and implement growth policies before it’s too late. The only reason why people aren’t openly admitting a recession could be that we still hope to get out of it. Once we admit we are in a recession, it will be much more difficult to get out of because of momentum and self-fulfilling prophecy.

In my mind, society should never just let recessions happen. We have fiscal and monetary policies for a reason. This isn’t colonial America or England during the industrial revolution. We are not completely subjected to the whim of the market anymore, but in fact can influence the economy. We are more advanced and have policies put in place to do exactly that. The Fed and government should do what is morally right to address the problems facing its people. Right now the main concern for many Americans is the economy. The answer is not to conclude a recession will be good for future growth and pray to God it is a little recession that can be managed. I believe the best course of action is tightening monetary policy during periods of boom to minimize the chances of a future recession or at least reduce its length and severity, instead of allowing recessions to occur. America cannot subject itself and the world to suffering so it can maybe benefit in the long term when we are all dead.

[1]Shawn Tully. Fortune. Will the Cure be Worse than the Disease? February 4, 2008.

[2] Stephen King. Weekly Economic Review. Misguided thinking of those who say recession would purge the system. February 11, 2008


1 comment:

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