insight: QE III: A solution to the looming double-dip recession? Send to a friend

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Saturday, 29 September 2012 09:30

Since 2008 the global economy has been in what is considered the greatest recession in contemporary times. As noted several times in this column the last economic crisis of this magnitude was seen way back in the 1930s in form of the Great Depression. Also, in the 1970s there was the Asian crisis. There have been various responses to the 2008 economic crisis. As part of policy responses we have witnessed various forms of Keynesian economy-wide stimulus packages to stimulate aggregate demand. We have also seen bailout plans to rescue strategic industries and firms that were deemed too large to fail. Part of the response that we have observed from the United States of America which is the epicentre of the 2008 crisis, include three ‘seasons’ of Quantitative Easing (QE). These are Quantitative Easing I (QE I), Quantitative Easing II and Quantitative Easing III. Today we will look at how QE III could be used to stop the world economy bleeding, effectively keeping the looming double dip recession at bay. Understanding Double-dip recession The concept of a double dip recession is used to describe a situation where the global economy goes into a second recession immediately after coming out of one. In the context of this article we would see a double dip recession if the global economy sinks into another economic crisis right after the 2008 nightmare. After the 2008 crisis started there have been some recovery albeit weak, fragile,uncertain and arguably unsustainable. There have been genuine worries that the global economy may go into yet another massive economic slump. Economic indicators point to a path to a possible double-dip recession. The numbers on unemployment and on general consumer and investor sentiment indicate that the US economy is struggling to fully come out of the woods. The Eurozone sovereign debt crisis is also causing fears that the global economy may go back to the growth path experienced when the 2008 crisis was at its  worst. Understanding Quantitative Easing Quantitative Easing (QE) is a form of government responses to economic crisis. This takes the form of printing money so as to make the cash-trapped economy more liquid. Between 2008 and September 2012 we have seen three Quantitative Easings in the USA. The aim is to reduce the severity of the 2008 economic crisis. In what follows we explore quantitative easing and  how it could be used to reduce the chances of a double dip recession. QE - double dip recession nexus There is a close relationship between quantitative easing as a policy tool to respond to economic crisis and ending the looming double dip recession. What happens in quantitative easing is indeed similar to what happens with stimulus packages. The main idea is to ‘print money’ and to make the economy liquid at times of severe liquidity limitations. Liquidity in a cash-strapped economic downturn is very important. Basic economic theory  suggests that liquidity stimulates aggregate demand which in turn must be responded to by increasing production. This increase in production will create employment or at least reduced layoffs (unemployment). Higher employment will generate more income a portion of which will be devorted to buying goods and services. The amount that will be devorted to consumption will depend on the consumers’ marginal propensity to consume - and by extension their marginal propensity to save. In simple terms this is the percent of ones’ income that is set aside for consumption and saving. Therefore quantitative easing can theoretically reduce the severity of the economic crisis and take the American economy and for that matter the global economy back to the much better pre-2008 growth path. Why question QE III? The above theoretical possibility of keeping the looming double-dip recession at bay by way of quantitative easing III is not without critics. From the world of practice, we have witnessed measures similar to quantitative easing three. These include the rather generous economy-wide stimulus packages, sector and industry specific bail out plans and quantitative easing one and two. These responses to the crisis notwithstanding, the world economy is still in danger. The responses have however reduced the severity of the crisis but one needs to question the sustainability of quantitative easing. There is a limit to how much money an economy – however large – can print  to mitigate an economic slump. Earlier cash-dishing out responses have not fixed the real problem. In the Euro zone that extra cash has fueled the sovereign debt crisis which in turn is posing the greatest possibility of a double dip recession. Austerity pulls back QE III   At the time when quantitative easing three is being rolled out in the US, many countries in the Euro zone are embracing austerity measures as a policy response to the Euro zone crisis. Austerity economics is seen when governments are attempting to bring spending in line with revenues. It is one of fiscal policy instruments that aim to reduce government budgetary deficits. Austerity measures have typically included austere budgets in which governments cut public spending. These have included reduced public sector salaries and wage freezes lasting a couple of years, reduced pensions, increased taxes, increased retirement ages and much more along those lines. We have observed very unpopular and much opposed austerity measures in such countries as Greece and Spain. As late as September 2012, the world has seen a number of anti-austerity measures demostrations in Spain and Greece. Looking at what it takes to ensure a rather strong, sustainable and less fragile economic recovery, austerity measures appear to be bad economics. This is because it takes expansionary fiscal and monetary policies and their instruments such as quantitative easing to help fix – albeit partly and temporarily - the broken global economy. These policies and their associated instruments are necessary for the much needed increase in - and sustenace of - aggregate demand. The author is a senior lecturer, researcher and consultant in Economics and Business at Mzumbe University Dar es Salaam Business School. pngowi2002@yahoo.com , +255 754653740