Tuesday, January 6, 2009

Economic Recession: The Only Panacea Is Demand Creation

To come out of the Economic Recession certain strategies are required and as we know in the text book of Economics that “Demand is the mother of production”.

Demand creation is the major and prime factor for the economy to come out of recession.

The basic question which arises in a laymen’s minds why demand evaporates, why consumers shy away from purchasing of products (goods and services).The  are reasons why they shies away from buying, spending and shopping.

Combat Liquidity Trap:

Liquidity crunch is considered to be major problem which arise during the recession, general people don’t have adequate disposable income to buy products and in turn there is a glut in the market and the manufactures and the businessman are stuck up with the products and services, an are force to sell product at loss or at break even.

Liquidity Crunch triggers recession and in turn the manufactures cuts the output and lays off employees. Job cuts and job freeze makes life difficult for people and an economy to sustain in the proper place.

With globalization and GATT in place the modern integrated global economy find it’s very difficult to survive. No economy is insulated from the global economic meltdown.

To break the vicious cycle the government plays the most pivotal role in by accelerating investments.

Active Role Of The Government.

According to Keynes during the recession the private entrepreneurs are skeptic in doing any further investments and prefer to minimize the investment role due to additional fear in mind of loosing money and capital. It is the governments and their bodies who should take a bold front and apply all financial mechanism to bail out firms who are loosing and not willing to do any farther investments. The stock market regulations are to be changed  for time being allowing the FIIs and retail investors to play safely and freely. In a free market economics the government’s role in the back side during the boom time, but it play the most important role during recession for baling out the economy from recession. Interest cuts which leverage the borrowing power of the entrepreneurs and the general public and in turn trigger of business activity and purchasing activity respectively. Inflationary trends generally are under control and the feel good factor amongst the entrepreneurs and general public should set in which in turn creates employments and demand in the market. The mixed economies of the world are in a better positing to trigger demands by buying for both the government bodies and pubic sectors. As public sectors and private sectors are dependent upon each other public sectors and government buying can easily pull up the private sectors demand and vice versa.

 Avoid:” Paradox Of Thrift”:

An In-depth look and government should come forward will it’s Fiscal Measures to over come this paradox and create enthuse amongst its people to create the demand by creating some confidence building measures and a favorable atmosphere by which people will be willing to buy and aggregate demand can be created.

As earlier said “Demand Is The Mother Of Production”, it’s of paramount importance for the government to create the demand by extending all benefits to the industry or bailing out industry and firms which can be turn around with fiscal measures, additional spending in infrastructure, housing, health care and labor intensive industry generating high employment and which in turn will create the aggregate demand.

 Taxes , Levies, Duties should be kept at a minimum level which in turn will attract the industry to go for production as well as interest the buyer to for shopping. A cut in income tax makes work more attractive. Therefore, the substitution effect of cost says people will work more. Interest rate cuts will also help the consumers to take additional loans for buying homes and other durable products, which in turn will trigger off demands for all allied industry. According to some Economist it’s the general consumers who have the keys in their hand to open to reopen the economic boom. It’s the sentiment which can’t be defined by economist but it very much a physiological factor which plays an invisible role in boosting the ailing weak economy.

 However, the Income effect suggests people may not work longer hours and increase supply of labors. This is because the income effect of a tax cut means people can get a certain income through working less hours.

Therefore there are 2 conflicting effects of a tax cut and it is uncertain whether supply of labor will increase. It depends what the tax rate was to start with.

E.g. if income tax was 70% a cut in tax may increase supply of labor.

Lower income tax increases disposable income, therefore, it may encourage people to spend more. There may be an increase in the aggregate demand for labor.

 However, it depends on marginal propensity to consume. e.g. if people save, buy imports or pay taxes then domestic product consumption doesn’t increase. For example, in a recession a cut in tax may lead to increased savings. People are not keen to spend more.

 If benefits are reduced they further reduced consumer spending and advertisements. This made areas of high unemployment even more impoverished. When people saved rather than spent their money it just made the recession worse. It was J.M. Keynes who was one of the most enthusiastic proponents of increasing government spending, even if it meant increasing the levels of borrowing.

If the government borrows they can kick start the economy and hopefully generate a multiplier effect which would enable the economy to start growing of course there is a fear of deficit financing.

In the United Kingdom and in US , Keynes was largely ignored until after the war and as a consequence the UK economy experienced high levels of unemployment for the remainder of the decade.

This particular phenomenon explains why Keynes talked about the “paradox of thrift”. Saving money reduces spending, output and therefore increases the level of unemployment in an economy.


Ethical and Prudent Banking Systems:

 An ethical Banking system and practice is required, the Central Banking systems should be given absolute power to work, and to regulate the all the activities of the banks.

Conservative approach may be required in the initial stages but in later stages it can be relaxed, but aggressive retail lending with increased interest rates along with low or no collateral's should be avoided. Over optimism of an industry should be avoided. Market Researches are not always correct; statistics may go wrong in some places.

 Aggressiveness Banking Business is good but Cautious Aggressiveness Banking Business is better. All Banks should appoint CEO (Chief Ethics Officer) and should have absolute power  and should report directly to the Finance and banking ministry.


 I have written this post with out elaborating the mathematical interpretation  and graphical interpretation in macro economics. I welcome suggestions from all readers of  this particular post  .I read about the IMF fact sheet and according to that Fact Sheet the prediction for 2009 is dreadful , lot of cautiousness is required to come out from the deep rooted crisis that has been created from the Sub Prime housing crisis in United States.

But if " Winter comes can Spring be far Behind" it is a general economic cycle of boom and bust according to the text books of economics the cycle will stay for 3-4 years but with modern financial mechanism it can be reduced to 1 1/2-2 years.

Hope 2010 will bring good news and the  global economy will be Honky dory.

Please Click :To Find The IMF World Economic Update 6th November 2008.


1 comment:

MC Shalom P. Hamou said...

The Right Monetary and Fiscal Policy Can not Get Us Out of the Depression

DIE ZEIT: Can the right monetary and fiscal policy keep the US out of a recession?

Alan Greenspan:

"Probably not. Global forces can now override most anything that monetary and fiscal policy can do. Long-term real interest rates have significantly more impact on the core of economic activity than the individual actions of nations. Central banks have increasingly lost their capacity to influence the longer end of the market.

Two to three decades, ago central banks were dominant throughout the maturity schedule.

Thus, the more important question is the direction of long-term real interest rates."

Alan Greenspan
The Great Irony of Success
© ZEIT online, 30.1.2008

A Credit Free, Free Market Economy will correct all of those dysfunctions.

The alternative would be, on the long run, to wait for the physical destruction (through war or rust) of most of our productive assets. It will be at a cost none of us can afford to pay.

A Specific Application of Employment, Interest and Money

Press release of my open letter to Chairman Ben S. Bernanke:

Sorry, Chairman Ben S. Bernanke, But Quantitative Easing Won't Work.

Yours Sincerely,

MC Shalom P. Hamou
Chief Economist & Master Conductor
1776 - Annuit Cœptis.