Most of the economists are concerned that the current global crisis might turn into something grave like the great depression of 1929 or even worse. In order to avoid that, the central banks round the world are taking steps to create more liquidity in their respective economies without realizing that this may aggravate the problem. Before making a new economic policy, it is important to see the past implications of that policy.
It was an artificial economic boom that was responsible for the great depression of 1929. For the entire decade before that, most of the companies throughout the world saw unprecedented rise in their profits. The economic growth came to a halt after the giant companies started facing losses due to lack of demand. It was the biggest recession in the history which lasted for a decade ruining world’s biggest economies of US and Europe. It all started when the US economy was becoming increasingly unstable due to widening disparity of income between the rich and the poor class which resulted in an oversupply of goods as people did not have income to buy those goods. Easy availability of credit and more investment were thought of to be the immediate solutions by the fed (the central bank of United States). Cash reserve ratio, statutory liquidity ratio and repo rates were all brought down in order to induce liquidity in the economy. This way artificial demand was created. However, most of the people were unable to repay the debts. The demand for the goods declined as most of the income of the people went to repay debts. Consequently, the investors’ confidence declined which reduced the production of luxury goods as well. The effect poured on to other nations as well. The world economy was trapped in an unusual vicious circle.
Something like this happened again in the 1990s when most of the banks got into home loans and mortgages. As the real estate prices were rising, this became an easy way for lenders to create money. The optimism led the banks to take up risky loans as well. The banks and investment companies got into the business of trading risk. Yet again, the same crisis of confidence approached when people found it increasingly difficult to repay the long-term debts. Some of the world’s largest banks like Lehman Brothers found themselves bankrupt. It did not take long to percolate the effect onto other companies as well. The giant companies like Sony, Motorola, DLF, AIG, Indian Inc, TCS, General Motors, etc have suffered heavy losses; millions have lost their jobs and the solutions to bring the declining growth rates back on the track are no where in the sight.
No one can deny that it is the lack of efficient financial regulations that is responsible for the present crisis. But criticizing past is not suffice to solve present problems. There is an urgent need of deploying efficient monetary and fiscal policies. Though, to increase the net investment, it is important that interest rates are kept at low levels but a major fiscal stimulus is needed for the world economy to flourish again. The Keynesian theory of government intervention was adopted to take the world economy out of the great depression. Government expenditure was increased substantially in order to induce spending in the economy. Multipliers worked well and the income and outputs rose by 1933. One major factor which helped the US key industries flourish again was rise in demand due to the onset of World War II. No one surely wants world war III to end recession! However, fiscal stimulus is the need of the hour. That is, the level of government expenditure should be raised and the taxes reduced. Further, the taxes should not be raised substantially in near future so that the optimism prevails and aggregate demand does not fall back again. The international banks (like World Bank, IMF) can also deploy efficient policies to induce liquidity in the global economy.
The importance of two most significant sectors- infrastructure and agriculture- is often understated. It is the growth in these two sectors which brings about rise in demand for all other industries (by increasing wages for a large number of people) and thus, higher overall economic growth. But not much attention is paid to these key sectors while policy formation. The rise in food production in US also played a major role in taking the economy out of recession. The governments should not ignore the agricultural sector completely. It is the high time that the governments invest in infrastructure wherever necessary.
In order to avoid the situation becoming more precarious like the Great Depression, more ‘aggressive’ policies are needed immediately.