Recession or Depression? Stimulate or Spend?
Small business owners tend to see the government just like they do their business. When the economy is depressed, common sense in business is to spend less and make sure to balance the budget to stay viable. For some, it is inconceivable that the government would spend just when the economy and the amount of its tax revenues diminishes.
"Even before the Great Depression, downturns were typically much deeper and longer than they are today (see right-hand chart). One reason why recessions have become milder is higher government spending. In recessions governments, unlike firms, do not slash spending and jobs, so they help to stabilise the economy; and income taxes automatically fall and unemployment benefits rise, helping to support incomes. Another reason is that in the late 19th and early 20th centuries, when countries were on the gold standard, the money supply usually shrank during recessions, exacerbating the downturn. Waves of bank failures also often made things worse."
Some small business persons project that if the government can do anything, the best would be to provide tax rebates and reductions to spark their customers to spend again. According to The Economist, what policy to use depends on whether we are in a depression created by an asset bubble or a recession created by high interest rates.
Before reading the excerpt, a couple of technical notes: Fiscal policy refers to government stimulating the economy directly through increased spending and cutting taxes. Monetary policy is about the regulation of the money supply and interest rates.
"But a recent analysis by Saul Eslake, chief economist at ANZ bank, concludes that the difference between a recession and a depression is more than simply one of size or duration. The cause of the downturn also matters. A standard recession usually follows a period of tight monetary policy, but a depression is the result of a bursting asset and credit bubble, a contraction in credit, and a decline in the general price level. In the Great Depression average prices in America fell by one-quarter, and nominal GDP ended up shrinking by almost half. America’s worst recessions before the second world war were all associated with financial panics and falling prices: in both 1893-94 and 1907-08 real GDP declined by almost 10%; in 1919-21, it fell by 13%.
The economic slumps that followed the collapse of the Soviet Union and those during the Asian crisis were not really depressions, argues Mr Eslake, because inflation increased sharply. On the other hand, Japan’s experience in the late 1990s, when nominal GDP shrank for several years, may qualify. A depression, suggests Mr Eslake, does not have to be “Great” in the 1930s sense. On his definition, depressions, like recessions, can be mild or severe.
Another important implication of this distinction between a recession and a depression is that they call for different policy responses. A recession triggered by tight monetary policy can be cured by lower interest rates, but fiscal policy tends to be less effective because of the lags involved. By contrast, in a depression caused by falling asset prices, a credit crunch and deflation, conventional monetary policy is much less potent than fiscal policy."
Unlike small businesses, the government should forget about balancing its budget for now. Although the numbers may be enormous, the order for government is to spend and stimulate.
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