Evaluating Crisis Management Options

Now as we know in a recession, typically the economy slows down, credit becomes expensive and exclusive, industrial output is negative or roundabout zilch, consumer confidence takes a toll and route to other cyclic gloomy events. In financial terms to sum it up; the investment dries up as private participants register heavy losses and stay bearish for a while.

Thus it is obvious that the emptiness in economy and even the financial markets have to be filled in by someone. That someone has to pump blood (that is money in this case) into the economy, in order to maintain life. That someone has to mend the loopholes, revise regulations and show sympathy to regain both public and private confidence in the system it governs. That someone has to wait for businesses to digest the losses, consumers to get more optimistic and investors to feel safe again. I hope you have realised by now that our ‘someone’ is none other than the government itself.

So now we know that it is the government only which is the final responsibility and authority to step in. The next thing to question is what all options it has to choose from:

1)      Spending large amounts of money or reducing taxes to increase money supply.

2)      Using central bank reserve and lending rates to boost money supply.

3)      Or do nothing and let the market and economy correct itself; as the classicalists suggested a century ago.

What is usually seen, is a combination of both the fiscal policy (first) and monetary policy (second). Moreover, what constraints the government to go the whole mile is the presence of the third option. Invariably it exists in the back of the mind of policy makers. It is brought to public domain in business journals and newspapers by some economists who remind about the benefits of perfect competition and warn about crowding out private investment. Sociologists will hark back to the founding principles of capitalism. In addition we are also alarmed by opposition political parties, who suddenly become more concerned about the tax payer’s “hard earned money”, raising slogans about their management (probably motivated as their own pockets get thinner too).

Thus a balance is maintained wherein prudent policy makers are stopped from overspending and crowding out private investment. So the government has to be very careful in order to not fuel a bubble in the economy which bursts as soon as it exits. Thus another major aspect is the timing of withdrawal of economic relief policy in both monetary and fiscal fronts. I will discus this in detail in my later posts.

It is also of course implied that a fiscal or monetary policy cannot be implemented in isolation. They both are interdependent on each other. The leakages in a policy can be countered by the other. For instance the concept of Quantitative Easing which is being adopted by central banks all over the world involves the central bank buying government securities in order to facilitate the fiscal expenditure. However if this was not done, the excess supply of treasuries would have pushed up interest rates and choked off investor confidence and credit flow in the economy.

Thus, we have seen what are the alternatives to be considered, which are evaluated on the basis of market and economic conditions. Now let us see what has really happened this time.