What goes Up must Come Down

The economy is a dynamic entity composed of various factors which interact with each other contributing to it’s over all health. It is a cycle which has its ups and downs.

There are five basic elements in an economy. They are producers, consumers, market, supply and demand. Producers of course produce the goods and services which are bought by consumers. We are all producers and consumers at the same time. We buy groceries produced by farmers, factories and other institutions. But we also produce labor or work which is also bought by the companies we work for. During the peak time in the economy, producers make the maximum amount of goods and services while the consumers also buy the maximum amount they can. This leads to a lot of money spent on goods and services leading to a bigger amount of demand. Since there is demand for more goods and services, producers can charge more for their products. This leads to higher prices which lead to inflation. When inflation reaches its peak, consumer demand for goods and services would start going down and since demand will go down, the suppliers will have an over supply of stocks or services. In other words, since people have stopped spending their money due to high prices, a surplus of goods and services has occurred in the market. When this surplus occurs, producers will have to cut production cost by either lowering their prices lest their customers buy from competitors or they lay-off workers in order to save on overhead costs. Unemployed workers will have even less money to spend, driving the producers to lower their prices even more. When prices are low enough, demand will again pick up and the cycle begins all over again.

Mr. Wesley C. Mitchell, more than 80 years ago, described how the “error of optimism at the heart of every boom grows in scope and magnitude. ... But since the prosperity has been built largely upon error, a day of reckoning must come. ... Then the past miscalculation becomes patent (evident) -- patent to creditors as well as to debtors, and the creditors apply pressure for repayment. Thus prosperity ends in a crisis."

Then, as Mitchell further adds, "The error of optimism dies in the crisis but in dying it 'gives birth to an error of pessimism. This new error is born, not an infant, but a giant; for the boom has necessarily been a period of strong emotional excitement, and an excited man passes from one form of excitement to another more rapidly than he passes to quiescence.'" This is why many will be blind to the light at the end of the tunnel that marks the exit from this recession.

As sure as the spring will follow the winter, prosperity and economic growth will follow recession.


What happens in a ‘Recession’?

1. Decline in economic activity brings recession causing unemployment, fall in income, consumption and therefore production. It enhances tendency to save more among people. However, mere parsimony is not economy. Expense may be an essential part in true economy.

2. Economic stagnation takes place, wherein productive capacity keeps on rising due to technological development of economy, but income-derived(wage) purchasing power (not the one derived from loans) of people do not rise in equal proportion. Extra working hours may sustain the purchasing power but it also has limit. In other words, shortage of money arises with people who actually create demand say, lower and middle class people and governments.

3. In recessions, interest rates tend to fall. Because inflation goes downside and central Banks wish to try and stimulate the economy.

4. The government will also try to use expansionary fiscal policy. This involves cutting taxes and increasing government spending. It will cause higher government borrowing (higher budget deficit), because Tax Cuts tend to stagnate Government revenues, discouraging increased government spending. Expansionary fiscal policy may not work in the long run due to crowding out.

5. Governments may try out both lower interest rates and lower taxes.

6. The problem with lower interest rates is that it is causing a further devaluation of the currency.

7. Also lower interest rates may not actually help increase consumer spending if confidence is low. In spite of Central Bank’s strict instructions, neither bank can throw money overstepping the norms, nor can people be inclined to take loans and buy more.

8. There is a limit to how much the government can cut taxes because government borrowing is already quite high. As the reports reveal, US national debt is about 65% of GDP. In the recession this will definitely increase. There is huge loss of revenue to government in the form of direct and indirect taxes.

9. Stock Markets fall because firms make less profit. There is also the danger of business establishments going out of business.