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Aren't Recessions Inevitable?

I am no expert in economics theory but I wonder if there is anything that can be done to prevent recessions in an open-market kind of economy. Here is my understanding of how this works.

The Good Times
Let’s say that we are in a period of relatively low unemployment. This means that almost everyone has a job, and so has some money to spend. With money to spend, people buy things – some essential, and some not so essential; that’s just human nature. So there are companies that are producing these things that people are buying, and they are seeing good sales and revenue. In order to sell more and boost their revenues, these companies offer “no payment for 6 months” kind of deals, and a great many people feel encouraged to buy things taking advantage of such offers. Now the companies and boosting their short term revenues by encouraging people to buy more than they could have if they had to buy everything on cash. And then there are the credit card companies, offering people credit, to do pretty much the same thing.

Now we have entered a phase where most people are working and earning, feeling generally good and secure, but also spending more money than they actually have at that point in time. Of course, their plan is to pay off all that they owe over time. But by the time they get there, there are more offers from companies, and from credit card companies to transfer balances at much lower interest rates. This gives people the feeling of being in a position to use available credit more effectively than they could before. So a lot of people buy more things.

Gets Even Better
While all this is happening, many of the companies are seeing higher and higher revenues, as people are spending more and more over time. People are spending the money that they don’t have, and what they pay is going to these companies as revenue. The companies are now seeing opportunites to expand their operations to produce more and sell more. So they are hiring more people to do exactly that. That improves the job market even more, and now people feel even more secure and happy, and are willing to spend more.

What Goes Up Must Come Down, And Go Up Again
As people spend more, the companies earn more, and hire more people, who in turn are earning more, and wanting to spend more. This is a vicious circle. It is like a system that is feeding itself to grow more and more, with no checks-and-bounds. In engineering terms, this is like a system with positive feedback that drives it to higher and higher amplitudes, until it becomes unstable. When it becomes unstable, it hits a limit where it cannot increase its amplitude any more and starts to wane. The waning causes more waning due to positive feedback, and soon the system is headed in the opposite direction. This process continues until it reaches a point where it cannot decrease in amplitude any more, and it slowly starts to increase again. This whole cycle will repeat endlessly.

Now stepping back from the engineering model, if we look at the capitalistic economic model, it is easy to see why peaks and valleys are inevitable. When the going is good, people keep overstretching themselves in their spending, and when there isn’t any more growth possible and credit left, things turn around and move rapidly in the other direction. When this hits the valley, it forces everyone to pull up their socks and look at what is really essential and live within whatever they can afford. In this state, the economy is purely based on the fundamental needs and so it naturally starts recovering. As it recovers, it starts fuelling itself and is soon headed to another peak.

Checks-and-bounds For Stability
Going back to the engineering model, it is a well-known fact that systems with the right amount of negative feedback remain stable and don’t get into oscillations — the wild swings between peaks and valleys. How would we apply this theory to the economic model? What kind of negative feedback would keep the economy stable? These would be some magic checks-and-bounds that the experts need to come up with.

Do We Really Want It To Be Stable?
But suppose we know exactly what these checks-and-bounds are, and we apply them to the economic system. It will most likely prevent peaks and valleys and keep things stable. That would mean steady job market, stable company revenues, and so on. It would also mean that no one can make a fast buck in the stock market or the real-estate market. Now, would that be exciting? Would the general population want that? Or would they rather prefer wild peaks and valleys, hoping that they will make a fortune during the peaks?

From what I have seen and think I understand so far, it does appear that people would prefer a fast-growing economy for all the excitement it offers.

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One Comment

  1. Irrational Economics Irrational Economics February 24, 2009

    […] In the midst of all the frenzied activity of the booms, I am sure many of us wondered how some of the things could be sustained over time. The web may accomodate an infinite number of  Amazons, cars.coms, and hotels.coms, but they are catering to only a finite number of people who are going to buy from them. How can the number of jobs keep increasing for ever? How can people keep buying costlier and costier homes? Where does the money come from? Doesn’t it mean that everyone is using money that doesn’t exist in the form of loans and mortgages? Aren’t recessions inevitable? […]

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