Link:http://www.economist.com/displaystory.cfm?story_id=13248177
Summary
This article reports on the recent measures that the Bank of England has undertaken to ease the effects of the recession on the economy. On March 5th the Central Bank lowered its interest rates, bringing the base rate down to 0.5 %. This decline in interest rates began in October when it was at 5%. A new policy of "quantitative easing" has also been started which involves the government buying debt securities, and private assets for 75 billion pounds ($105 billion) and pay for this with their own money. Quantitative easing is a common practice when banks have lowered their interest rates to zero and they want to ease further. It is intended to increase the money supply. This policy was also implemented to counter deflation. Consumer price inflation experienced a drop from 5.2 % last autumn to 3% in the year of January. It is predicted that it will drop to 0.7 % by the end of 2009 and with an economy in debt like Britain's, deflation would result in a deeper hole. The Bank of England also expects GDP to decline by 3% in 2009, the steepest drop since the second world war. The main purpose of quantitative easing is to prevent the money supply from taking a large hit and at the same time boost GDP by providing a large supply of money.
Connection to Chapter 6
The key component of this chapter would be Gross Domestic Product. GDP is effected by trends in investment and savings. There is a positive relationship between GDP and investment, more investment resulting in an increase in GDP. The challenge posed by banks in times of recession would be to provide incentives for people to invest and that is the situation presented in the article. By decreasing interest rates, the Bank of England is enticing consumers into borrowing loans in order to invest and increase the GDP. In times of recession, people are inclined to save which lowers the aggregate demand and less money will circulate the business sector, lowering GDP. This chapter also discusses the business cycle and one of the theories associated with it would be the monetary theory. The monetary theory states that changes in the money supply are key factors in GDP. The policy of quantitative easing was implemented to influence the GDP by increasing the money supply in order to boost economic expansion. The quantitative easing policy also has the power to bring the multiplier into effect on GDP as investment and consumption spending would increase. The expenditure multiplier would be necessary to take into account when measuring how effective lowering interest rates would be.
Reflection
The fact that the Bank of England is trying to fight deflation is a testament to the state of the GDP level in England. I personally remain sceptical about how effective these new measures will be considering the tendency for people to save in these discretionary periods. Most people in periods of recession would probably be hesitant to borrow loans even if under low interest rates due to the chance that they would have a hard time paying it off. Indeed the Paradox of thrift could also be applied to the current recession. People continue to save but it lowers business activity resulting in increased unemployment and a decrease in their ability to save. This of course has consequences on GDP as shown in England and the response of the bank is to decrease interest rates and increase money supply. I am also concerned about the state of GDP in Canada as the recession is expected to get worse after growth in GDP is reported to have slowed down over the past couple of months. After reading this chapter and the article above it has become clearer to me the challenges that governments and banks face in guiding a country through a recession. It is not as easy as simply lowering interest rates as the psychological state of people during recession tells them to save. Overall, consumer confidence must be restored in order to pull the economy out of the recession but doing this is no easy task for the banks and government.
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6 comments:
I completely agree with the fact that these measures are not effective to increase consumer's tendency to spend. It is human nature to protect oneself before others. In such times of uncertainty, consumer confidence towards spending is low. Hence, saving seems a much safer option to retain one's income rather than to spend even though the paradox of thrift denies this solution. Also, Even if interest rates are decreased, the effects of the sub-prime loan incident still lingers in the market. If there is distrust between consumers and banks, then the tendency to spend out of the recession will not happen. Hence, I agree with Jason that before we can get people to start spending, consumer confidence must be restored first. Yet, how to boost consumer confidence, is easier said than done.
John Hui
blk. F
Although lowering interest rates may help ease the economic situation, many more steps must be taken in order to get the economy going again. Large banks in many countries including England, The United States, as well as Canada are decreasing its interest rates to provide consumers the incentive to borrow money for investments. However, during this period of economic recession, the decrease in interest rate is unlikely to significantly increase the number of people who will borrow money for investments. This is due to the fact that many large companies have laid off a large portion of their workers. Consumers are increasing the amount they save in order to prepare for the future, in case they lose their job, or have to work part time. However, by decreasing the amount of consumption, the GDP decreases. As there is a decrease in consumption, there is an even greater chance that companies will lay off more employees. In any case, the government must take many more steps than simply lower interest rates to get out of this economic recession.
I would agree with you that people in this world wide crisis would be hesitant to borrow money from the government even if it’s as low as it is now. However, people will still borrow money still since the prices of many things have gone up as the unemployment rate too. Things cost more and to keep up with these expenses, there are no other ways but to borrow money from the bank. By lowering the interest rate, this can help stimulate the economy as there will be more of a cash flow in the economy which would increase the GDP.
Kathy Tang
Block F
I agree, this is a world issue of safe investment. People don't want to loss their money so instead they save. However if the interest rates become so low that the inflation out runs it, then maybe people will start spending more since keeping it in the banks will only devalue their wealth. By this point maybe it will have the paradox of thrift when people start to invest because the expectations are that the economy is in such a bad state, that people think it will be the lowest it can be. By this time it our economy will probably see a turn for the better. This lower interest rate will probably benefit businesses that hope to sustain their current full capacity factories. So in many ways i disagree that these low interest rates are a bad idea, but I do see what point this is coming from.
M.Sun
Blk F
Ever since the recession began, there have been countless number of countries basically promoting the benefits you receive if you decide to borrow a loan from the banks. In such times, where the confidence level of most people are still at uncertainty, this has significantly depleted the cash flow running through the economy for most countries. What this has resulted in, is a low business activity resulting in increased unemployment and a decrease in their ability to save. Thus, I completely agree with your reflection because I don't think the banks can do anything right now to jump start the economy, since the psychological mind of most people feels that the economy does not exude any confidence.
Eric Leung
Block E
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