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Recession: easy to fix?

  1. Jan 4, 2008 #1

    EnumaElish

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    One thing that the government can do is to speed up favorite government programs, while promising solid supply-side gains in the not too distant future.

    Look at it as another regional war that needs troops and money immediately.

    Thoughts? Comments?
     
  2. jcsd
  3. Jan 4, 2008 #2

    ShawnD

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    The recession is caused by a lot of things.

    National Debt
    As a percentage of GDP, national debt looks like this. Some guy is using Canada as a reference (last 20 years). Canada's highest debt was 60% around 1995, lowest is 40% right about now (and going down). US lowest was ~35% in 1980, highest was ~65% in 1995, currently at ~60-65% and going up.
    Just by comparing with Canada you can see the US is in bad but recoverable shape. The debt is not a runaway train, but it's still way too high. Get rid of Homeland Security, stop the Iraq war, and maybe withdraw military forces from other countries like Germany or wherever. That debt can easily be lowered if somebody cares enough to try. Might need to raise taxes too.

    Liquidity
    Canada's economy closely follows the US, and I can tell you first-hand that liquidity is not in good shape right now. You can't get a loan right now unless you can prove you don't need the loan in the first place. This can sometimes lead to what's called the Liquidity Trap:
    "In monetary economics, a liquidity trap occurs when the economy is stagnant, the nominal interest rate is close or equal to zero, and the monetary authority is unable to stimulate the economy with traditional monetary policy tools. In this kind of situation, people do not expect high returns on physical or financial investments, so they keep assets in short-term cash bank accounts or hoards rather than making long-term investments. This makes the recession even more severe.
    [.....]
    In a liquidity trap environment, banks are unwilling to lend, so the central bank's newly-created liquidity is trapped behind unwilling lenders."

    So people wanting money can't get money. Want to start a business? No can do. New home? Go to hell. Of course this leads to even more problems...

    Housing Crash
    Housing was going up, now it's not. People bought investment properties so they could be landlords, and now their rates for rent are less than the mortgage itself. The mortgage may have been $1500 when you bought the house, but the flood of housing caused the rent price to be maybe $1400 for that house, oops. No more home building means people in construction take a hit. Roofers lose their jobs, as do plumbers, electricians, general labor, carpenters, etc. The people making and sellling the wood, nails, cables, whatever, are also hit. Now that prices are super low, you still can't buy a house because the bank won't lend you any money! Awesome!

    Sub-Prime
    Liquidity is low because of the sub-prime crap. People were given huge loans they couldn't possibly afford, and now they're defaulting on payments. Banks are no longer willing to lend money to people unless they have the best credit score on the planet. Interest rates have gone down to encourage lending, and that causes a different kind of problem.

    Low Interest Rates
    Low interest rates can do a lot of things. They can make the economy grow by having more money move around faster, or they can stop the economy because there's no reason to lend money to whomever wants money. US and Canada are pretty close right now, so look at Canada's expected bond yields. 4% yield on a 10 year bond? Are you kidding? I wouldn't buy that crap, and neither should you. If I get a bank account with ING Direct they'll give me 3.75% and the money is not locked in. There's no incentive for me to lend money to anybody in the form of buying a bond. It's a very bad situation when nobody is willing to lend money. This causes low liquidity on the side of people who buy bonds. The other side of low liquidity is caused by the sub-prime backlash.



    Not a simple situation. It'll take a few years to recover from this one.
     
  4. Jan 5, 2008 #3
    The US economy is potentially very inflationary right now. The last thing we need is more debt and raising taxes would really kill off economic activity.
     
  5. Jan 5, 2008 #4
    ^^ Excellent review ShawnD - thanks.
     
  6. Jan 5, 2008 #5

    turbo

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    The trick is raising taxes and lowering taxes strategically. Bush got it backward. Cutting taxes on the wealthy was stupid, reducing revenues while spending got 'way out of hand. If he wanted to stimulate the economy, he would have raised taxes on the upper-income group, while lowering taxes for the middle class. The middle class tends to spend about everything they make, and they spend it in ways that stimulate their local economies. Our system of taxation is highly regressive, such that people at the low-to-middle ranges of income pay a much higher percentage of their incomes in taxes. Our government(s) levy sales taxes, excise taxes, property taxes, fuel taxes, etc, etc. Advocates for the wealthy like to point to capital gains taxes, inheritance taxes, and income taxes as if the wealthy should not pay a fair share. Warren Buffet is a refreshing counter-example.
     
  7. Jan 6, 2008 #6

    EnumaElish

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    High debt doesn't "cause" recession any more than living in a big house with a big mortgage causes a productive family to go bankrupt.

    A medium level of inflation may not be a bad thing for a highly indebted economy; the trick is to minimize the variation in the rate of inflation (the uncertainty component). A steady 5% per year increase in the overall price level may not be a bad thing.

    Low liquidity clogs up the economy because productive investments cannot find financing -- but those investments are exactly those that fuel long-run economic growth. But with markets flushed with liquidity, bad investments also continue to fester. What is needed is a selective rule that weeds out the good from the bad investment; and unsupervised private financiers have proven to be bad in this -- they just could not turn away from lucrative profits at the expense of making bad loans. Someone has to hold the bag now, and I am guessing that direct government programs may be a better instrument at this than the Fed flushing out liquidity in an undirected way.
     
  8. Jan 6, 2008 #7

    ShawnD

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    Not true. Thousands of people are going bankrupt right now because they got low interest rates on their mortgage then the rates went up and they couldn't afford the mortgage payments. Government debts are the exact same way. The government will issue bonds at maybe 3%, then when those bonds mature, the interest rates might be up to 6%. In order to maintain the same level of debt, the interest being paid literally doubles. If the government had no debt in the first place, it wouldn't matter what bonds rates are because they wouldn't need to issue bonds.


    When inflation goes up, interest rates go up. Canada had rampant inflation in the 1970s and simple GICs were paying as much as 10%. Mortgages on homes were around 15%. Your debt doesn't just magically disappear through inflation since the interest rates go up to match that inflation. Right now is a low teaser rate, but wait a year and it will go up to match the level of inflation the US has right now.

    What you're saying probably will happen. Banks probably will get a bailout, and the economy will recover. The alternative is to do nothing, let banks hold those bad loans, and end up looking like Japan and go into a 10+ year recession.

    edit: please read that article I linked to. What happened to Japan is very similar.
     
    Last edited: Jan 6, 2008
  9. Jan 7, 2008 #8

    EnumaElish

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    Mine was not the best example. Having stated that, fixed-rate debt does not have this repercussion. Moreover, debt can also avert or postpone a recession. The unqualified statement "debt causes recession" is too general to be useful policy advice.

    Just in passing, a sovereign government has a unique device to pay up debt denominated in national currency: it can always print more currency. In that sense, sovereign debt has even less potential to cause short-term problems than, say a mortgage loan.

    Again, that would depend on whether the bulk of the debt is variable rate or fixed rate. In the early 2000s, when the interest rates were lowered to help out the stock market, "rational" people expected interest rates to go up in the near future, so they took fixed (or semi-fixed) rate mortgages.

    The main problem with inflation is the uncertainty component. I have seen evidence that uncertainty was the main component of inflation that resulted in depressed economic activity in the U.S. in the 1970s and early '80s (the era between the Vietnam war and the Volcker Fed under the first Reagan admin.), rather than the increase in the prices, on its own.
     
    Last edited: Jan 7, 2008
  10. Jan 11, 2008 #9

    EnumaElish

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    I think the Clinton anti-recession plan is a step in the direction I suggested in my OP.
     
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