Why We Need The Recession

Posted on 15/10/2010

1


While the thrust of this article is undoubtedly controversial, I feel that many people are forgetting that a recession is a normal part of the business cycle and the processes that take place during a recession are necessary to lay the groundwork for any recovery.  Below are some of the key reasons why we need the current recession:

  1. A recession forces individuals, companies and governments to undertake a cost-saving exercise, weeding-out expensive suppliers and unnecessary purchases, thus improving allocative efficiency within the economy.
  2. A recession forces companies to re-examine of production/operating processes to maintain margins/stave-off bankruptcy, leading to innovation and permanent improvements in productivity.
  3. The cyclical down-turn in demand for certain goods and services puts weaker companies within various industries out-of-business. This may mean they are taken-over, they merge, they break-themselves up or they are liquidated. This allows some or all of the resources which they had utilised (land, labour, physical capital, financial capital) to be released for more productive use elsewhere in the economy or better-quality management to take control of the reources.
  4. Elevated levels of unemployment creates downward pressure on wages within an economy, helping to rebalance the supply of and demand for labour. These reduced wages mean labour productivity is improved, increasing the competitiveness of firms operating within the economy. By paying generous out-of-work benefits or subsidising uncompetitive firms to keep employees on the payroll, governments are in fact either maintaining unemployment at a higher level than it might otherwise be, or giving investors in ailing firms a free option at the expense of taxpayers.
  5. The company bankruptcies and personal insolvencies that occur during a recession force banks (and other lenders) to write-down loans and mortgages to levels that can realistically be repaid. Until this process has occurred, investor and depositor confidence cannot return to the banking system as these agents continue to have concerns about the solvency and liquidity of the banks. By bailing-out companies or individuals, governments are in effect taxing the thrifty to underwrite the exuberance of the profligate. This increases moral hazard within the economy and some would argue is unjust and has the potential to damage the fabric of society.
  6. Increases in government deficits, reductions in interest rates and declines in consumer demand for imports typically lead to a fall in the FX rate during a recession, allowing firms within the economy in question to regain their competitiveness in world export markets.
  7. Reductions in interest rates to below average levels make it cheaper for firms to raise finance for new investments.  Low interest rates also reduce the opportunity cost to investors of holding more speculative assets, encouraging capital to be redeployed at longer maturities or in more subordinated financial assets to improve returns.
  8. Reductions in prices of financial assets that typically occur during a recession often reveal frauds which may have otherwise gone unnoticed.
  9. Brings an end to speculation and asset-price bubbles that may have gotten out-of-hand, to the detriment of the economy (and society) as a whole. Such bubbles significantly reduce allocative efficiency as they encourage resources to be deployed in a sub-optimal manner.

Governments and central banks, by desperately implementing various policy measures in a futile attempt to keep their economies growing are actually interfering with many of the mechanisms described above, which in my opinion simply delays the adjustment process that developed-world economies need to undergo. As a consequence, although the recession may be less painful, its length could well be extended and the pace of eventual recovery significantly slowed.

A recessions forces individuals, companies and governments to undertake a cost-saving exercise, weeding-out expensive suppliers and unnecessary purchases, thus improving allocative efficiency within the economy.

Re-examination of production/operating processes to maintain margins/stave-off bankruptcy, leading to innovation and permanent improvements in productivity.

The cyclical down-turn in demand for certain goods and services puts weaker companies within various industries out-of-business. This may mean they are taken-over, they merge, they break-themselves up or they are liquidated. This allows some or all of the resources which they had utilised (land, labour, physical capital, financial capital) to be released for more productive use elsewhere in the economy.

Elevated levels of unemployment creates downward pressure on wages within an economy, bringing, helping to rebalance the supply of and demand for labour. These reduce wages mean labour productivity is improved, increasing the competitiveness of firms operating within the economy. By paying generous out-of-work benefits or subsidising uncompetitive firms to keep employees on the payroll, governments are in fact either maintaining unemployment at a higher level than it might otherwise be, or giving investors in ailing firms a free option at the expense of taxpayers.

The company bankruptcies and personal insolvencies that occur during a recession force banks (and other lenders) to write-down loans and mortgages to levels that can realistically be repaid. Until this process has occurred, investor and depositor confidence cannot return to the banking system as these agents continue to have concerns about the solvency and liquidity of the banks. By bailing-out companies or individuals, governments are in effect taxing the thrifty to underwrite the exuberance of the profligate. This increases moral hazard within the economy and some would argue is unjust and has the potential to damage the fabric of society.

Increases in government deficits, reductions in interest rates, and declines in consumer demand for imports typically lead to a fall in the FX rate during a recession, allowing firms within the economy in question to regain their competitiveness in world export markets.

Reductions in interest rates to below average levels make it cheaper for firms to raise finance for new investments.

Reductions in prices of financial assets that typically occur during a recession often reveal frauds which may have otherwise gone unnoticed.

Brings an end to speculation and asset-price bubbles that may have gotten out-of-hand, to the detriment of the economy (and society) as a whole. Such bubbles significantly reduce allocative efficiency as they encourage resources to be deployed in a sub-optimal manner.

 

Governments and central banks, by desperately implementing various policy measures in a futile attempt to keep their economies growing are actually interfering with all of the mechanisms described above, which in my opinion simply delays the adjustment process that developed-world economies need to undergo. As a consequence, although the recession may be less painful, its length could well be extended and the pace of eventual recovery significantly slowed.

A recessions forces individuals, companies and governments to undertake a cost-saving exercise, weeding-out expensive suppliers and unnecessary purchases, thus improving allocative efficiency within the economy.

Re-examination of production/operating processes to maintain margins/stave-off bankruptcy, leading to innovation and permanent improvements in productivity.

The cyclical down-turn in demand for certain goods and services puts weaker companies within various industries out-of-business. This may mean they are taken-over, they merge, they break-themselves up or they are liquidated. This allows some or all of the resources which they had utilised (land, labour, physical capital, financial capital) to be released for more productive use elsewhere in the economy.

Elevated levels of unemployment creates downward pressure on wages within an economy, bringing, helping to rebalance the supply of and demand for labour. These reduce wages mean labour productivity is improved, increasing the competitiveness of firms operating within the economy. By paying generous out-of-work benefits or subsidising uncompetitive firms to keep employees on the payroll, governments are in fact either maintaining unemployment at a higher level than it might otherwise be, or giving investors in ailing firms a free option at the expense of taxpayers.

The company bankruptcies and personal insolvencies that occur during a recession force banks (and other lenders) to write-down loans and mortgages to levels that can realistically be repaid. Until this process has occurred, investor and depositor confidence cannot return to the banking system as these agents continue to have concerns about the solvency and liquidity of the banks. By bailing-out companies or individuals, governments are in effect taxing the thrifty to underwrite the exuberance of the profligate. This increases moral hazard within the economy and some would argue is unjust and has the potential to damage the fabric of society.

Increases in government deficits, reductions in interest rates, and declines in consumer demand for imports typically lead to a fall in the FX rate during a recession, allowing firms within the economy in question to regain their competitiveness in world export markets.

Reductions in interest rates to below average levels make it cheaper for firms to raise finance for new investments.

Reductions in prices of financial assets that typically occur during a recession often reveal frauds which may have otherwise gone unnoticed.

Brings an end to speculation and asset-price bubbles that may have gotten out-of-hand, to the detriment of the economy (and society) as a whole. Such bubbles significantly reduce allocative efficiency as they encourage resources to be deployed in a sub-optimal manner.

Governments and central banks, by desperately implementing various policy measures in a futile attempt to keep their economies growing are actually interfering with all of the mechanisms described above, which in my opinion simply delays the adjustment process that developed-world economies need to undergo. As a consequence, although the recession may be less painful, its length could well be extended and the pace of eventual recovery significantly slowed.

A recessions forces individuals, companies and governments to undertake a cost-saving exercise, weeding-out expensive suppliers and unnecessary purchases, thus improving allocative efficiency within the economy.

Re-examination of production/operating processes to maintain margins/stave-off bankruptcy, leading to innovation and permanent improvements in productivity.

The cyclical down-turn in demand for certain goods and services puts weaker companies within various industries out-of-business. This may mean they are taken-over, they merge, they break-themselves up or they are liquidated. This allows some or all of the resources which they had utilised (land, labour, physical capital, financial capital) to be released for more productive use elsewhere in the economy.

Elevated levels of unemployment creates downward pressure on wages within an economy, bringing, helping to rebalance the supply of and demand for labour. These reduce wages mean labour productivity is improved, increasing the competitiveness of firms operating within the economy. By paying generous out-of-work benefits or subsidising uncompetitive firms to keep employees on the payroll, governments are in fact either maintaining unemployment at a higher level than it might otherwise be, or giving investors in ailing firms a free option at the expense of taxpayers.

The company bankruptcies and personal insolvencies that occur during a recession force banks (and other lenders) to write-down loans and mortgages to levels that can realistically be repaid. Until this process has occurred, investor and depositor confidence cannot return to the banking system as these agents continue to have concerns about the solvency and liquidity of the banks. By bailing-out companies or individuals, governments are in effect taxing the thrifty to underwrite the exuberance of the profligate. This increases moral hazard within the economy and some would argue is unjust and has the potential to damage the fabric of society.

Increases in government deficits, reductions in interest rates, and declines in consumer demand for imports typically lead to a fall in the FX rate during a recession, allowing firms within the economy in question to regain their competitiveness in world export markets.

Reductions in interest rates to below average levels make it cheaper for firms to raise finance for new investments.

Reductions in prices of financial assets that typically occur during a recession often reveal frauds which may have otherwise gone unnoticed.

Brings an end to speculation and asset-price bubbles that may have gotten out-of-hand, to the detriment of the economy (and society) as a whole. Such bubbles significantly reduce allocative efficiency as they encourage resources to be deployed in a sub-optimal manner.

Governments and central banks, by desperately implementing various policy measures in a futile attempt to keep their economies growing are actually interfering with all of the mechanisms described above, which in my opinion simply delays the adjustment process that developed-world economies need to undergo. As a consequence, although the recession may be less painful, its length could well be extended and the pace of eventual recovery significantly slowed.

Advertisements
Posted in: Economy, My Thoughts