Unit 2, 4 & IGCSE: Macro-Economic Policies to avoid recession

Depressingly soon after the great recession of 2009, global economies look to be entering another recession. If we are not technically in a recession, it already feels like it.


Are there any policies which can avoid recession?

David Cameron recently wrote a letter to the leader of the G20 talking about the necessity of improving global economic growth. It was a little vague as to how this economic recovery would occur. He mentions 'tackling key problems' and criticised US and EU for not doing enough to confront the debt overhang to prevent a wider contagion to the wider global economy. Unfortunately, this prognosis offered by Cameron does little to 'restore confidence'. The UK is a good example of how an economic recovery has been sniffed out because the government placed too much importance on short term fiscal austerity at the wrong time. We are not really in a position to preach about the virtues of boosting economic growth.

To imagine the world economy can be fixed by concerted efforts to reduce government spending and reduce government debt is not the case. Yet, politicians seem to have a habit of equating debt with recession as if they are the same thing.

Austerity measures have dampened confidence. They have cause a rise in unemployment and the private sector hasn't taken the place of the government. It may be surprising to some. But, if you depress the population by repeatedly talking about austerity, job cuts and spending cuts, it is almost inevitable.

The UK and US have more options than the Euro members because they don't have the problems of liquidity fears which seem to paralyse Euro bond markets / single monetary policy / floating exchange rate.

It is interesting that the crisis has caused the yield on US treasury bonds to fall to the lowest level since the 1940s. This means investors want to buy US government bonds. It suggests markets fear a recession much more than a US government default.
Policies to Avoid Recession

Fiscal Policy

Short Term stimulus / Long Term Structural change.

The government should boost spending. They should take advantage of the low bond yields. This increase in discretionary fiscal stimulus will

Boost Aggregate Demand

Create jobs

Improve business and consumer confidence.

At the same time, the government should set out concrete plan to deal with long term spending commitments. It should make decisions which reduce long term entitlement spending.

e.g. raise retirement age

Evaluation of health care spending -

Caps on cost of health care

Increase taxes (delayed till after recession)

Here Cameron is right that there needs to be a strong political will to do the right thing. I doubt the US has this political will to agree on either short term stimulus or long term fiscal consolidation.

This combination of long term structural changes will reassure markets about debt. The short term fiscal stimulus will reassure markets, the government is committed to increasing GDP.

Governments need to understand economic growth is a KEY factor in reducing debt/ GDP ratios. You will never get to grips with a debt crisis if you plunge your economy into a recession.

Monetary Stimulus.

Federal Reserve's Operation Twist. This is a move in the right direction. Buying long dated mortgage bonds, helps to keep mortgage interest rates low and can help boost spending / investment. Markets fear it is too little too late. The Federal Reserve may need more quantitative easing to provide monetary stimulus.

Quantitative Easing. Creating money electronically and buying long term securities can have a role in increasing money supply and economic growth.

Higher Inflation Target Now is not the time to worry about inflation. Headline CPI is misleading because it includes temporary cost push factors. The Monetary authorities should be targeting 'core inflation'. This may in practise mean a CPI rate of over 2%. But, that is not the problem. Otherwise in 2012, we could see a period of deflation which would be disastrous for the economy.

Lower Interest Rates

The ECB should reverse its decision to raise interest rates earlier in the year. Only the ECB would increase interest rates as the world economy was heading into a double dip recession. When will the ECB realise there are worse things than a temporary blip in cost push inflation?

However, an interest rate cut of 0.5% would only have a limited effect in boosting EU growth. Much more is needed, but at least it would be a signal they are interested in boosting growth.