Entries Tagged 'recession' ↓

With talk of recession in the UK and US, the outspoken chairman of Ryanair, Michael O Leary, recently suggested that recessions actually have many advantages. His argument was that recessions encouraged greater efficiency and forced inefficient firms out of busines. In this essay “Is a recession a good thing?”, I argue that broadly speaking he is wrong; recessions tend to undermine economies and create unnecessary unemployment.

Nevertheless are there some people who benefit from a recession.

1. People producing inferior goods like Tesco value bread and Buses. Demand for these goods may rise in a recession.
2. Pawnbrokers.
3. Pubs and Betting shops. It is alleged that in a recession people like to drown their sorrows and bet on winning a few pounds. I don’t know how true this is; to be honest is sounds like an old wives tale.
4. Economists. Everyone wants to ask economists why we are in a recession and how to get out of a recession. Generally speaking economists are very good at answering the first question.

• Causes of recessions?
• For more ideas there is a good article at the Guardian newspaper on recessions

Readers Question: What will happened to the income of business sector if there is an economic decline in America?

An economic decline in the United States, is pretty much guaranteed to reduce the income of the business sector. The recent falls in the US stock markets are largely due to  expectations of a future downturn in the economy. Lower growth leads to lower profits, therefore dividends decline and shares become less attractive. If the US enters into recession, firms will experience a decline in profitability. This is because:

1. Tendency for price wars to develop in a recession. Low sales encourage firms to cut prices
2. Falling sales will lead to lower revenues.

Some firms will be affected more by the downturn. Firms producing luxury goods (Income elasticity of demand >1) will experience the biggest % fall in demand. This is likely to include manufacturers of luxury cars, 5 star hotels. Firms producing basic necessities will be more insulated from the effects of a recession.

With the US heading towards recession, there are several things being done to try and avoid recession. Basically, the government and monetary authorities need to try and increase Aggregate Demand and also increase consumer confidence. There is no guarantee that they will work.

Policies to avoid a Recession

1. Cutting Interest Rates.  Recently, the Fed cut interest rates by 0.75% a big stimulus for consumer spending. Amongst other things, lower interest rates reduce mortgage interest payments, giving consumers more disposable income. – Fed Cut Interest rates by 0.75%
   
2. Freeze on Subprime Mortgage Rates. There is a 5 year scheme to freeze subprime rates, preventing house repossession. Effects of Freezing subprime rates
3. Tax Cuts. Cutting taxes increases consumer disposable income. But, will people spend if they are nervous about the future? Can tax cuts avoid a recession?
4. Increase in Government Spending. Higher government spending is another way to stimulate the economy. The US has not announced much in this area. They are hampered by budget deficit and preference for tax cuts.
5. Devaluation. The devaluation of the dollar is not particularly a policy, it is something that is just happening. However, the weaker dollar is boosting the US export sector and could help avoid recession. Effects of devaluing dollar.

Related

Can UK and US avoid Recession?

Difficulties in getting out of a recession 

In a recession, fiscal policy and monetary policy can, in theory be used to increase Aggregate Demand and boost economic growth. However in practice there can be many difficulties with boosting a countries economic growth rate and reducing unemployment.

• Problems in recovering from recessions
• Why Do Recessions last a long time

1. Confidence. In a recession confidence may be so low that cuts in interest rates and taxes do not have the effect  of increasing demand. For example the liquidity trap says that lower interest rates are ineffective in increasing spending because they do not change people’s behaviour at certain times

2. Hysteresis. This is an argument that when unemployment is high it is difficult to change that fact. – Workers become deskilled and demotivated. Therefore, even an increase in AD doesn’t solve unemployment because many workers don’t have the relevant skills and capacities to get a job.

3. Paradox of Thrift. – In a recession people often want to save. But, this just makes the recession worse. It can lead to a negative multiplier effect. A fall in spending leads to less output. Lower output creates unemployment and so even more people have less skills.

• Paradox of Thrift 

How would a recession in the US and EU affect the UK economy?

Over 75% of UK trade is with the US and EU. Therefore, a recession in these countries would have a significant impact.

Firstly, UK exports to these countries would fall. Therefore, the UK is likely to have a fall in AD, (or at least lower growth)
Therefore, the UK would experience a lower rate of economic growth. The impact of this fall in exports will depend upon several other factors. The impact will depend upon other factors affecting UK domestic demand. For example, if UK house prices continued to rise and consumer spending remained buoyant, then the UK would be able to avoid an economics downturn.

Continue reading →