Are we headed for a recession? Or are we about to hit the long predicted Depression?
How bad are things going to be over the next couple of years?
A few points to consider....
A recession is a contraction in real GDP, brought on by a tight central bank policy (usually to fight inflation), that ends when the central bank eases it's policy.
It is relatively well managed via interest rate changes. Lowering interest rates stimulates the economy in three ways
1) it reduces debt service burdens,
2) it stimulates demand for items bought with credit by lowering the monthly payments (e.g., cutting interest rates in half has nearly the same effect in cutting the cost of buying a home as cutting the purchase price in half) and
3) it raises the present value of income-producing assets thus producing a wealth effect.
So, lowering interest rates ends recessions and produces cyclical expansions.
A depression is a deleveraging process in which asset price declines cause already over-leveraged entities to become more leveraged and cash-strapped, leading them to be squeezed for cash and creating credit-tightening conditions which cause an economic contraction in which monetary policy ceases to work, generally because interest rates have fallen close to 0%, making meaningful interest rate cuts impossible.
Because interest rates can’t be cut, the three previously mentioned stimulations that cause the economy to grow do not occur.
As a result, the “cost cuts” that occur take place via deflation leading to real interest rates increases. Rising real interest rates raise debt service burdens and lower income-producing asset values and a self-reinforcing downward spiral occurs – i.e., as asset values and incomes fall, so do credit worthiness, lending activity and economic activity.
A depression is, most fundamentally, a shortage of liquidity relative to the need for it to service debts that has to be resolved by some mix of writing down debts and producing more liquidity without lowering interest rates.
So....
With interest rates in the US falling to 1.5%, are we entering a recession (assuming you are not one of those still insisting we won't feel it here in BC), or is this the start of another Depression?
Care to share your thoughts?
How bad are things going to be over the next couple of years?
A few points to consider....
A recession is a contraction in real GDP, brought on by a tight central bank policy (usually to fight inflation), that ends when the central bank eases it's policy.
It is relatively well managed via interest rate changes. Lowering interest rates stimulates the economy in three ways
1) it reduces debt service burdens,
2) it stimulates demand for items bought with credit by lowering the monthly payments (e.g., cutting interest rates in half has nearly the same effect in cutting the cost of buying a home as cutting the purchase price in half) and
3) it raises the present value of income-producing assets thus producing a wealth effect.
So, lowering interest rates ends recessions and produces cyclical expansions.
A depression is a deleveraging process in which asset price declines cause already over-leveraged entities to become more leveraged and cash-strapped, leading them to be squeezed for cash and creating credit-tightening conditions which cause an economic contraction in which monetary policy ceases to work, generally because interest rates have fallen close to 0%, making meaningful interest rate cuts impossible.
Because interest rates can’t be cut, the three previously mentioned stimulations that cause the economy to grow do not occur.
As a result, the “cost cuts” that occur take place via deflation leading to real interest rates increases. Rising real interest rates raise debt service burdens and lower income-producing asset values and a self-reinforcing downward spiral occurs – i.e., as asset values and incomes fall, so do credit worthiness, lending activity and economic activity.
A depression is, most fundamentally, a shortage of liquidity relative to the need for it to service debts that has to be resolved by some mix of writing down debts and producing more liquidity without lowering interest rates.
So....
With interest rates in the US falling to 1.5%, are we entering a recession (assuming you are not one of those still insisting we won't feel it here in BC), or is this the start of another Depression?
Care to share your thoughts?
