How to Respond to Economic Slodown and Economic Recession

Introduction

A recession can be defined as a decline in the Gross Domestic Product (GDP), or negative real economic growth, for two or more successive quarters of a year. A recession in general involves decline in concurrent measures of overall economic activity such as investment, employment and corporate profits. An example of economic recession would be the early 90s economic recession in Europe. It can be seen from the figures in the table below the economic growth levels went to negative which denotes the recession in the economy.

Figure 1

In practice an economic recession is often confused with economic slowdown. Economic slowdown is likely to last for a short duration of time or may result in a recession if persistent for a longer period. An extremely relevant for this would the US economy; like it can be seen from the graph below it is not facing a recession yet since the economic growth is still 2 %; which is positive but an economic slowdown and is expected to enter into a recession if the economic growth keeps declining.

Figure 2

Analysis and Discussion

A government's response to an economic slowdown is similar to that of an economic recession since in both the cases levels of economic activity are affected though in the latter to alarming level; bringing them back to normal would be the prime motive of a government.

The government can either use demand side macroeconomic policies comprising of monetary and fiscal policy or opt for supply-side policies depending on the inflation levels. Demand side policies aims to stimulate the aggregate demand by increasing or decreasing public spending and investments. It can be seen from the figure increased aggregate demand results increase in price level.

Figure 3

Supply side policies on the other hand, affect aggregate supply in the economy. They are about increasing our workforce's productivity, and so include improving education and welfare reforms. The increase in demand does not affect the price level.

Figure 4

If the inflation levels are high boosting economy with demand side policies wouldn't be a good option and supply side policies should be considered. Government should use them during an economic slowdown where inflation levels can still be high unlike a recession.

As a part of demand side polices Government can use expansionary monetary policy in order to increase the money supply in the economy. The most influential way to increase the money supply would be reducing the reserve requirement. The percentage of money that the bank is not allowed to loan out is called the reserve requirement. If it is lowered, more money is put out into circulation (theoretically) since banks are required to keep less money.

The other way of increasing the money supply in the economy is through open market operations. Central bank can sell government securities in order to increase the money supply in the economy.

Central bank can also lower down the interest rates in order to stimulate AD. Lower interest rates will reduce the cost of borrowing and the incentive to save and encourage investment and spending. People would spend in fixed assets in place of saving it in the bank. This increased investment in the economy will shift the aggregate demand to right boosting economic growth.

The central bank in the UK has cut down the interest rates drastically to overcome the current economic slowdown in the UK. It can be seen from the figure below in less than a year interest rates have been reduced to 0.5%.This is expected to result in increased investment through borrowing.