Following the success of the clunkers program, consumer spending remains at record low levels which is no surprise considering the preceding chain of events. According to a Yahoo news source, economists expect consumers to continue to spend less, save more, and trim debt to household finances decimated by the recession into better shape. Even though this is the type of responsible behavior we’d like to see as a nation moving forward; it doesn’t necessarily necessitate a rebound. But, this is the type of behavior that should be expected. Following the Great Depression, most families strove to pay off their homes first and foremost prior to any investment towards their future. This change in behavior isn’t the end of the world, actually much the opposite. But, it is a consumer behavior that our government must recognize and accommodate for.
As Mark Williams, professor of finance and economics at Boston University notes “It’s true that consumers are being more responsible, saying “I don’t really need that extra credit card, ‘but it is more related to banks clamping down on lending.” So this reduction in borrowing is no just restricted to the consumer. Banks seem to be heading to a more conservative route that they will most likely continue to ride for years to come.
So in sum, consumers and banks seem to be traveling the more conservative and responsible route. However, this isn’t the type of route that dictates an economic boom. So, it’s important to monitor congress’s approach towards fiscal easing at this point. The private sector has taken a swing for the better on the global scale, but it’s clear that it can’t fully sustain itself at this point in the game. Government intervention is still needed, but on a lesser scale.
Tuesday, September 22, 2009
Friday, September 4, 2009
Balance Sheet Recession Part 1
As devastating as this recession has been to the psyche of the general public; nations have endured much worse.Prime examples include our Great Depression, and Japan’s Great Recession. Each of these events unleashed suffrage well over 10 years. In comparison, our circumstance seems rather trivial when placed up against these economic disasters. However, they underscore the overwhelming potential of sustained economic downturn if managed incorrectly. Nevertheless after reviewing these individually, it’s clear that we can establish correlations between the past and current. And, our ability to learn from the past will most certainly determine our future.
In both events, the burst of bubbles triggered the initial economic downturn. When this occurs, asset prices begin to plummet. In most cases, basic monetary policy is the proper anecdote. For instance, the Federal Reserve will reduce interest rates in order to sustain borrowing demand. This is effective in most scenarios because normal economic downturns fail to ravage balance sheets en masse. However in the case of extreme events defined as balance sheet recessions, the drops in asset prices are so devastating that firms begin to change their behavior. For instance, firms will halt borrowing and begin paying down debt. This is known as debt minimization. This occurs because firms must report solvent balance sheets. If firms fail to do so, banks have the power to turn off the credit spigot, and demand cash settlements, placing the firm’s survival in jeopardy (pg. 15). If this is being done en masse, aggregate demand will decline sharply, thus causing a deflationary spiral.
Amidst a balance sheet recession, borrowers show very little responsiveness to interest rate reductions. It’s for this reason that monetary policy is virtually ineffective at combating a balance sheet recession alone (pg 11). During both disasters, Japan and the U.S.dropped interest rates to record low levels, and borrowing demand was unresponsive. So, aggregate demand continued to spiral downwards with no end in sight. It’s then not surprising that unemployment reached 20% and home values dropped on average between 30-40% in the U.S during the Great Depression. It’s imperative to understand that the lack of demand is due to the firms change in behavior. Rather than borrowing for future endeavors, firms are paying down debt. The problem’s root is at the borrower, not the lender. So by attempting to reform the lender will prove futile.
In our current situation, borrowing remains unresponsive despite extremely low interest rates. This is because the economic downturn in numerous industries has been so massive that virtually everybody has been affected. Currently, there are many forces at work that we haven’t seen in this sequence in a long time. These include the energy crisis, housing market, and the financials. I believe that it’s safe to presume that these downturns have been so immense that they have effectively changed firm’s behavior on an aggregate level. Doesn’t this seem eerily similar to past scenarios?
It’s clear that fiscal stimulus is the only route to sustain aggregate demand, because you will not receive it from the private sector.Even amidst objections to fiscal stimulus, careful analysis will prove that these quarrels are unsubstantiated. It’s important to understand that in both Japan and the Unites States the budget deficit increased substantially in the periods without sustained fiscal stimulus amidst a recession in comparison to periods of commitment fiscal spending. Clearly, the fiscal spending during a balance sheet recession is not the ideal situation, but it sure beats the alternative. Japan can stand testament from their 15 years of lost innovation and education. Households were barely staying afloat, and families didn’t have the income to send their children to universities. As a result, they are now beginning to lag behind their Asian counterparts. As can Great Britain who accumulated unspeakable debt during World War II, roughly 250% of their GDP. Should they have just succumbed to Hitler or Stalin? This debt did not prevent Britain from entering an elite status. There is no magic percentage of debt to GDP that sends an economy into a collapse. It wasn’t at 250%, and it’s not where we sit at now. Bring on the doom and gloom, but I’m just not buying it. However, that shouldn’t undervalue the importance of a well managed budget. I do strongly urge that our budget must be handled much more efficiently.
I agree with the route that we’ve taken as a country, but we’re only half way there. Fiscal consolidation should be enacted immediately after fiscal stimulus is no longer needed for growth, and firms have switched to profit maximization. This is when we can begin to chip away at our national debt. However, it’s important that fiscal easing, and then fiscal consolidation occur at the right times. If not, it could send our country back into a recession which would mean more debt and lost time. The future of our economy is in our government’s hands.
Koo, Richard C. The Holy Grail of Macroeconomics. Wiley, John & Sons Incorporated: August 2008.
In both events, the burst of bubbles triggered the initial economic downturn. When this occurs, asset prices begin to plummet. In most cases, basic monetary policy is the proper anecdote. For instance, the Federal Reserve will reduce interest rates in order to sustain borrowing demand. This is effective in most scenarios because normal economic downturns fail to ravage balance sheets en masse. However in the case of extreme events defined as balance sheet recessions, the drops in asset prices are so devastating that firms begin to change their behavior. For instance, firms will halt borrowing and begin paying down debt. This is known as debt minimization. This occurs because firms must report solvent balance sheets. If firms fail to do so, banks have the power to turn off the credit spigot, and demand cash settlements, placing the firm’s survival in jeopardy (pg. 15). If this is being done en masse, aggregate demand will decline sharply, thus causing a deflationary spiral.
Amidst a balance sheet recession, borrowers show very little responsiveness to interest rate reductions. It’s for this reason that monetary policy is virtually ineffective at combating a balance sheet recession alone (pg 11). During both disasters, Japan and the U.S.dropped interest rates to record low levels, and borrowing demand was unresponsive. So, aggregate demand continued to spiral downwards with no end in sight. It’s then not surprising that unemployment reached 20% and home values dropped on average between 30-40% in the U.S during the Great Depression. It’s imperative to understand that the lack of demand is due to the firms change in behavior. Rather than borrowing for future endeavors, firms are paying down debt. The problem’s root is at the borrower, not the lender. So by attempting to reform the lender will prove futile.
In our current situation, borrowing remains unresponsive despite extremely low interest rates. This is because the economic downturn in numerous industries has been so massive that virtually everybody has been affected. Currently, there are many forces at work that we haven’t seen in this sequence in a long time. These include the energy crisis, housing market, and the financials. I believe that it’s safe to presume that these downturns have been so immense that they have effectively changed firm’s behavior on an aggregate level. Doesn’t this seem eerily similar to past scenarios?
It’s clear that fiscal stimulus is the only route to sustain aggregate demand, because you will not receive it from the private sector.Even amidst objections to fiscal stimulus, careful analysis will prove that these quarrels are unsubstantiated. It’s important to understand that in both Japan and the Unites States the budget deficit increased substantially in the periods without sustained fiscal stimulus amidst a recession in comparison to periods of commitment fiscal spending. Clearly, the fiscal spending during a balance sheet recession is not the ideal situation, but it sure beats the alternative. Japan can stand testament from their 15 years of lost innovation and education. Households were barely staying afloat, and families didn’t have the income to send their children to universities. As a result, they are now beginning to lag behind their Asian counterparts. As can Great Britain who accumulated unspeakable debt during World War II, roughly 250% of their GDP. Should they have just succumbed to Hitler or Stalin? This debt did not prevent Britain from entering an elite status. There is no magic percentage of debt to GDP that sends an economy into a collapse. It wasn’t at 250%, and it’s not where we sit at now. Bring on the doom and gloom, but I’m just not buying it. However, that shouldn’t undervalue the importance of a well managed budget. I do strongly urge that our budget must be handled much more efficiently.
I agree with the route that we’ve taken as a country, but we’re only half way there. Fiscal consolidation should be enacted immediately after fiscal stimulus is no longer needed for growth, and firms have switched to profit maximization. This is when we can begin to chip away at our national debt. However, it’s important that fiscal easing, and then fiscal consolidation occur at the right times. If not, it could send our country back into a recession which would mean more debt and lost time. The future of our economy is in our government’s hands.
Koo, Richard C. The Holy Grail of Macroeconomics. Wiley, John & Sons Incorporated: August 2008.
Subscribe to:
Posts (Atom)