Saturday, January 10, 2009

A long and deep recession ?

As was said on the Wall Street Journal lately, this recession is not like the previous ones. Hence one should be careful when hearing politicians say that the recession would be over in 2009.

The reason is that the western world has no money. The government, household and companies had been relying lately on the generosity of China, Japan, South Korea and the Oil producing nation for credit. To understand why this is bad lets recapitulate on the different forces acting in a recession that push it towards a recovery.

1. Government spending

As the economy worsens, the aggregate spending in the economy falls. This is due mainly to reduced spending by household and by reduced investments by companies. In theory, as Keynes would recommend, the government would have to increase spending and decrease taxes so that household would have more disposable income.

In a "normal " recession the government would borrow the money and things would be OK. But in this case many countries have large public debt and increasing it would cause debt repayment to reach unsustainable level. Countries that used to lend to developed countries( named above) are more and more unwilling to lend so even if government want to borrow, they might not get the money.

2. Household savings

In a "normal" recession people have a lot of savings. So if they are out of work they are able to tap into the rainy day fund. This would cause them to continue spending. As a result the downturn would be softened a little bit. However in this recession the people have mostly dept. As unemployment increases, these people will have no money. They would then be a burden on the government as unemployment benefits increases. They would also most likely spend as little as possible worsening the recession.

These two factors would most likely cause an upswing to be less likely in the next six month. I would think that everyone would have to clean their houses before a recovery can kick in. Throwing money at it would most likely not help.

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