Showed this to my IGCSE class today – great video which is well put together with good examples that explain a recession and its causes. Particularly apt for today’s economic environment. Makes good use of supply and demand graphs as well as supply side and demand side variables. Detailed explanation of the business cycle. Useful for NCEA Level 2 growth standard.
Like after the GFC in 2008 can China kick start the world economy? The FT’s global China editor James Kynge explains why China’s indebtedness means it is probably both unwilling and unable to launch a stimulus package like that of 2009. A lot depends on how quickly their own economy can bounce back and if it is a L U V W shaped recovery. Also can it act as a locomotive for the rest of the world. The video below contains some excellent graphs concerning China’s debt problem.
Although from 2011 the video below from the PBS Newshour shows reporter Paul Solman and Simon Johnson – former IMF economist and now at MIT. Johnson explains the different types of recoveries – L U V W shapes.
It is unavoidable that recessions are part of the economic environment that we live in. In tackling the impact of recessions it has become apparent that one cannot solely rely on expansionary monetary policy of the central bank. Economic conditions have changed, as if an economy was to fall into recession in this low interest environment monetary policy options are far more limited than they were post the GFC. Add to this a higher debt level and you put further pressure on the banking system. A publication this year entitled “Recession Ready – Fiscal policies to stabilise the American economy.” (Published by the Hamilton Group – Washington Center for Equitable Growth) suggests that governments should assist in ensuring that the recovery phase is much quicker than it has been by ensuring confidence amongst businesses and households so they resume investing and spending again. They focus on antirecession programmes known as “automatic stabilisers.”
Automatic stabilisers are the automatic increases in revenues and decreases in expenditure in the government budget that occur when the economy strengthens, and the opposite changes that occur when the economy weakens.
Increase in GDP growth = the government will receive more tax revenues – people earn more and so pay more income tax. As it is assumed that unemployment decreases the amount of money spent on unemployment benefit decreases.
Reduction in GDP growth = lower incomes – people pay less tax. As unemployment increases the government spends more on unemployment benefits. This increase in benefit spending and lower tax collection helps to limit the fall in aggregate demand.
One of the chapters written by Claudia Sahm proposes a direct payment to individuals that would automatically be paid out early in a recession and then continue annually when the recession is severe. During a recession consumer spending (C) declines sharply – see graph – and as it makes up above 70% of most countries aggregate demand – C+I+G+(X-M) – this can lead to employment losses and reduced output. Consumers therefore are integral to boosting aggregate demand and direct stimulus payments to individuals should become part of the system of automatic stabilisers as additional income translates quickly into additional spending.
Trigger to start automatic stimulus payments.
The idea behind this is for direct payments to individuals after a 0.5% in the quarterly unemployment rate. If you look at each recession since 1970 the stimulus trigger of an increase in 0.5% unemployment meant that payments would have been triggered within three months of the start of the past six recessions (USA). But there are some concerns with using unemployment data:
- Unemployment rate tends to lag the business cycle as unemployment tends to peak after the recession ahas ended.
- The rise in unemployment doesn’t necessarily mean you are in recession – two consecutive quarters of negative GDP.
Lump sum v Tax cuts
There is an argument that a one-off lump sum payment is much effective in boosting spending than changes in income tax which would be spread fiscal stimulus throughout the year. Even if the Marginal Propensity to Consume (MPC) was the same for both lump sum and tax cuts it would not be until early in the next year that the full spending occurred under the tax cut option. The delay in spending from lump sum payments would be three months thus the overall stimulus boost would be both larger and more rapid – see graph below.
Direct stimulus payments would quickly deliver extra income to millions of households at the start of a recession and maintain income support until the recession has subsided. This should generate more aggregate demand and thereby reducing the impact of the recessionary phase.
Source: “Recession Ready – Fiscal policies to stabilise the American economy.” (Published by the Hamilton Group – Washington Center for Equitable Growth)
Here is another very useful video from CNBC which focuses on what actually is a recession. By definition it is two consecutive quarters of negative GDP. Between 1960 and 2007 there were 122 recessions in 21 advanced economies although those economies were only in recession around 10% of the time. The video is well worth a look and presenter Tom Chitty does a good job explaining things.
Ryan Avent of ‘The Economist’ considers how the next recession might happen — he asks the following questions:
- When will the next recession be?
- Where will it begin?
- Is the world prepared for a recession?
- What are the obstacles?
- What should governments do?
Very good viewing for macro policies – Unit 4 and 5 of the CIE A2 Economics course.
With the downturn in an economy, cutting interest rates has been the favoured policy of central banks. But the use of quantitative easing (QE) might mean the end of conventional monetary policy with rates already at record low levels – by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth. The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.
Last Sunday there was a very good interview with Canadian economist Armine Yalnizyan on Radio New Zealand’s ‘Sunday’ Programme (with Wallace Chapman). She mentions that the neoliberal policies of the last 30 years have seen income inequality grow and the collapse of consumer spending (C) the main driver of any domestic economy. There has been an increase in the proportion of income accruing to assets which worsens inequality in many countries. China would be an economy that has relied a lot on its export sector (X) for growth but is now trying to drive domestic demand (C) to generate growth. Remember that Aggregate Demand = C+I+G+(X-M). She makes the point that corporates favour the return for shareholders rather than for example
the wages of employees.
“We have this very unusual situation here where corporations are gaining in strength for a host of reasons, similar to the type of corporate power 100 years ago, in key sectors of the economy with less ability to either tax a proportion of the profits they make or regulate their activities.”
Boosting the minimum wage is stimulatory
She also mentions an increase in the minimum wage being stimulatory with lower income groups spending a much higher proportion of their income and thereby increasing consumption. And the vast majority of this spending happens in the domestic economy – C↑. Some have talked of wage inflation by increasing the minimum wage but with the fall in trade union membership and bargaining power this has been significantly reduced. In fact we have seen wage compression.
He-cession and She-covery
However later on in the interview I was interested to her explanation of He-cession and She-covery during the interview.
Recession = “he-cession” – more men tend to become unemployed as areas that are initially impacted by the downturn are manufacturing, mining, construction etc which are likely to be male dominated.
Recovery = “she-covery”: men who lose $30 an hour jobs wince at accepting $15 an hour offers, but women grab them to make sure the bills get paid.
David A. Rosenberg an economist with Clusken Sheff in Canada, has likened the world economy to that of a car being driven by a drunk – that is the car is moving back and across the centre line just missing the ditches on the side of the road. Currently he sees the car in the middle of the road although he questions as to whether this is due to the driver becoming more sober or steering towards the ditch on the other side.
Recently the US stock market (Dow Jones Industrial Average) went above 14000 for the first time in more than five years for the following reasons:
1. Better job figures – employers added 157,000 jobs in January and hired more workers in 2012 than had previously been thought. See chart below.
2. Corporate earnings have been stronger than expected,
3. US Federal Reserve has indicated that it will keep interest rates at near zero levels as well as continuing their policy of monthly $85 billion purchases of bonds and mortgage-backed securities, which injected $3 trillion into the banking system last week.
This third point is particularly important. In the New York Times, Rosenbery stated that he didn’t see the US economy in a recession as yet but could quickly go in that direction. “Anemic growth is my baseline scenario.” Also how long can the US Fed keep propping up equity markets and pumping money into the system? The conditions in Europe are not much better – unemployment rose to record levels in December last year and currently stands at 26.8% in Greece and 26.1% in Spain. Add to that the austerity measures which have impacted greatly on overall aggregate demand and the consumer slowdown in Germany, the eurozone area has its problems. So the car might be in the middle of the road right now but it might not take too much for it to deviate from a safe path.
Below is a graphic showing the levels of unemployment for each month since 1948 and if the economy during that time was in a recession (square in cell). Some points of note:
*In 1953 the level of unemployment was between 2-3% but the US economy was in a recession for the latter part of the year
*The majority of 1960 saw recessionary conditions with unemployment around 6-7%
*1974-75 the economy experienced stagflation – high unemployment and high inflation
*1980-83 periods of high unemployment – the early Reagan years and free market policies.
*1998-2001 – very low levels of unemployment followed by the impact of the 9/11 attacks and the recession that followed
*The financial crisis of 2008 saw 19 consecutive months of recession and unemployment reached between 10-11% in 2009. Since then it has been above 7%.
James Surowiecki of The New Yorker recently looked at the so-called rebound of the US economy. In February this year 200,000 new jobs were created and real incomes were growing also. Other indicators have been positive, for instance new car purchases have increased and the their are signs that aggregate demand is going up. But this demand is not necessarily coming from higher incomes from greater hours worked but the increasing number of young adult Americans living at home – see graph. This means that they have more income to spend on other items rather than rent/mortgage etc. In the article Surowiecki mentions data relating to the number of households.
1947 to 2007 – number of households in the US increased every year,
2008, 2010 and 2011 – number of households dropped even as the population grew.
Economist Scott Sumner came up with the expression Demographic Depression which has been a major cause of the weak recovery. The construction of new homes normally contributes greatly to the level of economic activity but when people are doubling up, there’s little demand for owning or renting. This also impact on peripheral items such as white wear items etc. However when doubling up ceases then we can say that there should be an increase in demand for housing, rentals, and white wear items. Research of past recessions shows that when unemployment falls household formation rebounds quite strongly. But global conditions and commodity prices could lead the Fed to tighten monetary policy but this would be going against what their stand of 0% interest rates to 2014.
Nouriel Roubini – New York University said in 2005 that homeowners have become too used to financing their spending by borrowing against their property. This is all very well until the value of the house declines. Today he says we are going to have further problems in the world economy in 2013/2014 when China faces the situation that the USA experienced in 2008. The world will question how solvent China is and the subsequent chaos will cause a massive global downturn – see news clip below from CNBC.
Richard Wolff (a prominent Marxist economist) – stated that in 2008 that the bursting of the housing bubble would bring about a crisis that would seriously affect American confidence in capitalism and subdue the economy for a long period of time. Shortly after saying this Lehman Brothers went bankrupt.