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Recession, depression and economic stimulus

In December of 2007, the global economy entered into the Great Recession triggered by the bursting of the housing bubble in the United States and subsequent global financial crisis.

The conventional definition of a recession is two or more consecutive negative quarters of Gross Domestic Product. It is a period of reduced economic activity typically accompanied by high unemployment, falling stock markets, low consumer confidence, decreased capacity utilisation, and a decline in home values.

A depression is sustained long-term drop in economic activity, involving multiple economies. Although there is no definitive definition, a depression can be characterised by as prolonged recession for two years or more with a decline of 10 percent or more in Gross National Product, substantially high employment, extremely tight credit conditions, significantly reduced trade, deflation, and public fear and panic.

The Great Recession ended in June of 2009 for the United States, officially lasting a period of 18 months, the longest period of economic decline since the Great Depression of 1929 to 1933.

Unemployment has remained stubbornly high in the US, consumer confidence is still low, real estate prices continue to slide, and personal bankruptcies are on the increase. Many feel the economy remained in a recession and may actually be in a depression.

There is concern that the world economy may enter into a double dip recession, or W shaped recession. This occurs when an economy enters a recession, emerges from it with a short period of growth, and then falls back into recession again. The accompanying chart of the early 1980ss recession is an example of double dip recession. In contrast a normal recession is V shaped, where an economy enters into a sharp but brief period of decline, with a clearly defined bottom, and then recovers robustly.

Monetary policy is a critical force in combating a recession. Monetary policy is the regulation of the supply of money and interest rates by the monetary authority of a country, usually a central bank, in order to promote economic growth, control inflation, maintain low unemployment and stabilise the currency.

The tools used by a monetary authority to prevent or fight a recession are lowering interest rates and an expansionary policy to increase the total supply of money in the economy more rapidly than usual.

The intent is to ease credit conditions and encourage spending by consumers and businesses. A contractionary policy would conversely moderate money supply growth, or potentially shrink it, and increase interest rates in order to tame inflation and cool an economy growing too fast.

With interest rates at close to zero and conventional monetary policy not having the desired effect, the US, UK and Eurozone nations have used an unconventional monetary policy called quantitative easing or QE. The process involves the central bank purchasing a pre-determined amount of bonds or other assets from financial institutions in order to increase the money supply, raise the price of financial assets bought, and lower their yield.

The US central bank held about US$750 million of Treasury Notes on its balance sheet before the recession of 2008. In June 2010, it held a peak of $2.1 trillion of bank debt, Mortgage Backed Securities and Treasury Notes. Post execution of QE1 and QE2, many in the market are calling for Q3. Perhaps we can learn a lesson from Franklin Roosevelt’s “New Deal”.

Anthony Galliano is chief executive of Cambodian Investment Management.
anthonygalliano@covenantim.com

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