Mike Walden's You
Decide: Is the economy inherently recession
Dr. Mike Walden
North Carolina Cooperative
Most of us focus on decisions affecting our daily
lives – earning an income, spending, investing and
looking ahead to our retirement. If we have some
time left over, we try to have fun! Businesses face
similar choices about production, advertising,
workers and pricing. Even public institutions like
schools, parks and transit systems have to make a
wide range of management selections.
Economists call these types of choices microeconomic
decisions because they deal with individual
entities, such as a household, a business or a
government agency. These entities are trying to make
decisions to advance their overall objective, like
happiness for a household or profits for a business.
However, we don’t live in our own individual
economic worlds. Our economic worlds are
interconnected. Individuals earn income by working
for businesses. Businesses earn income by selling to
individuals and to other businesses. Governments
levy taxes on individuals and businesses in order to
support public services like national defense, the
court system and roads.
individual economic players together forms the
macroeconomy. Until a century ago economists didn’t
pay much attention to the macroeconomy. Then came
the “Long Recession” of the 1870s, the “Great
Depression” of the 1930s and several other less
serious economic downturns interspersed.
became abundantly clear that changes in the big,
interconnected macroeconomy could adversely impact
households and businesses – even if those households
and businesses were making the best economic
decisions for their individual situation.
great deal of economic brain power has been expended
in the last century attempting to understand the
macroeconomy – and particularly what causes the
macroeconomy to periodically go into a tailspin. One
conclusion that some economists have reached is
perhaps rather startling – that the macroeconomy is
inherently unstable and recession-prone.
argument is actually simple. When the economy is
doing well and expanding, sales and profits
increase, incomes grow and optimism about the
economy’s future becomes more widespread. People see
nothing but “blue skies” ahead. Lenders feel the
same way, so they lower lending standards to allow
both households and businesses to take on more debt.
All is well as long as the economy grows, and
nothing happens to disrupt the general optimism. Yet
it could be something small, like an uptick in
interest rates or lackluster corporate earnings, or
it could be something big, such as a foreign war or
international default, that ultimately upsets the
Once optimism about the
economy is shattered, people begin to worry.
Investors sell rather than buy. Businesses delay
expansion plans and cut payrolls. And, perhaps worst
of all, some households and businesses find they
can’t meet their debt payments. If lenders, such as
banks, aren’t paid and depositors fear their money
isn’t safe, a “run on the banks” can set off
widespread economic panic and a macroeconomic
recession – or worse.
We saw this scenario
unfold during the most recent recession. Optimism
about the economy and particularly the housing
market fueled record-high debts in the early 2000s.
But pessimism took over in the late 2000s and the
economy experienced the housing crash, debt defaults
and the worst recession in 70 years.
have institutions and programs, like the Federal
Reserve and federal deposit insurance, to cushion
the blows of recessions. There were no bank runs
during the recent recession, although there were
“runs” on non-bank lenders, and the Federal Reserve
had to scramble to contain them.
Still, if we know that excessive economic optimism
eventually leads to unsustainable borrowing and a
recessionary correction, can public policy makers
impose controls to bring more stability to the
This is a big,
big question in economic policy circles – one that
has been debated for decades. One option is for
government to attempt to moderate the growth of
credit during “boom times.” The Federal Reserve has
some tools to do this, including the ability to
limit the amount of bank deposits that can be
loaned, as well as the interest rate charged on
loans. Also, federal legislation passed in the
aftermath of the recent recession has added some
further restrictions on bank lending.
course, such controls and limits have downsides
because they restrict the ability of borrowers to
obtain funds which, in turn, causes the economy to
grow slower than it would have without the controls.
This is a common explanation heard today about why
business expansion and job growth are lagging in
many parts of the economy.
So our economy
may have – as part of its nature – periods of ups
and downs related to general feelings of optimism
and pessimism. Do we have to live with this cycle,
or is there a way to have a smoother economic road
ahead? Thousands of smart people have tried to
answer this question. You decide if they’ll ever get
Dr. Mike Walden is a William Neal Reynolds Professor
and North Carolina Cooperative Extension
economist in the Department of Agricultural and
Resource Economics of N.C. State University’s
College of Agriculture and Life Sciences. He
teaches and writes on personal finance, economic
outlook and public policy. The College of
Agriculture and Life Sciences communications unit
provides his You Decide column every two weeks.
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