Inflation, Fiscal Monetary Policy
When we look at the developed world which is largely affected by this significant recession we see that a rapid decline in output levels of firms and failing banks have led to higher unemployment numbers. This leads us to the comparison between what is the bigger public enemy at this present situation in developing versus developed countries. With countries like India, China and brazil continuing to grow (at a slower pace) in the recessionary years we see that the developing countries still want to reduce poverty as it is the major problem faced whereas developed world with this looming recession and crunch credit is facing grave jobless rates and a declining output in the manufacturing sector and lower retail sales levels.
How to Control the Financial Meltdown
The article talks about a number of options that could be potentially used to control the financial meltdown and bring back major economies to stability. We must understand that certain banks and financial institutions must be allowed to fail because unless that is done we will not get to the bottom of this crisis and governments will not have to fill gaps through debt given the fact that major economies worldwide already have launched multi-100 billion dollar packages to rescue their ailing financial and other sectors. This decision would be difficult for certain countries as they have deemed a few organizations as too big to be allowed to fail against some others which continue to go bankrupt. Governments will have to adopt stronger communications policies to counter such issues as debates on which companies should fail and which shouldnt.
Another way of looking at things is that because financial institutions and investment companies are so interwoven, dependent on each other that to solve these messes governments needs to come up with industry wide solutions rather than company specific solutions. For instance governments should look to tighten up credit-default swap markets and other types of derivative markets which have caused a downward spiral in the debt portfolio of banks and other institutions.
What also should be looked at is the fact that depositors should be given greater protection so that the confidence in the banking industry is restored and strengthened such that there is no possibility of run on banks or losses for depositors in case a particular bank defaults. Banks should also look to diversify their bases in terms of lenders and profit making products so that unsystematic risk could be further reduced in the future.
Role of Inflation as a Policy Instrument to Control the Economic Recession
A lot of economists have termed inflation as the necessary evil such that governments need to provide their economies with a burst of moderate inflation to stimulate growth and production. There are certain advantages of inflation which include business growth, rising value of assets, greater present day spending, and falling debt values. In this current scenario the rising level of debt through the economies of the world means that future consumption might be depressed as lesser money would be used to spend in the future while more money would be used to pay off current debt. This means that if governments decide to allow moderate inflation by encouraging central banks to print money and buy government debt than we might have a scenario where the real value of debt would start to decline (Ezine Articles, n.d).
This would positively affect many indebted businesses as well especially the mortgage house market which must lose more value in terms of real price levels. The article suggests that the prices in the housing market should still fall by 15 (article published in 2008) so if that is the case than a rise in inflation would require housing prices to fall by less than 15.
An advantage of printing money is that governments can earn seigniorage revenue which means that governments can earn from the net benefit from the difference between cost of producing money and its actual value. This difference could be used to fund government expenditure, without charging any more additional taxes.
We should also look at the advantage of better business growth in a moderate inflationary time period. This occurs because as prices rise people would start purchasing more today because the value of their income would be lesser in future because of inflation secondly businesses would also have the incentive of higher prices to produce more goods and services hence supply would also rise. The prices of stocks would also increase allowing investors to come back to capital markets and increase the opportunity for businesses to expand through IPOs or rights issue this is an important way (raising capital from the public) of generating newer projects and jobs.
Central banks and governments must be careful with inflation because they dont want to be in a situation where the economy is choked by unsustainable inflation levels of 20 or 30. If inflations gets out of control than the situation can go horribly wrong simply because spending would be significantly curtailed in terms of buying goods that are not necessary. Central banks must look to balance the inflation expectations with the supply of money and also ensure fluid communications policy so that investors and businesses are aware of the steps taken by the central banks all the time.
Fiscal and Monetary Policy as Tools to Control and Stimulate Growth
There are a number of monetary and fiscal policy combinations that governments across the world can use to solve the economic crisis and financial issue. Firstly, governments should look to start with the right basics. Banks should lend to entrepreneurs and businesses which are essentially the backbone of any economy. Secondly taxation should be way of facilitating businesses rather than a hindrance to business expansion and investment. Therefore governments in the developed world should look to encourage investments so that jobs are created and more consumer expenditure is witnessed (Rogoff, 2008).
By ensuring adequate liquidity in the market the central banks of major economies can keep interest rates low and allow businesses cheap funds for investments. Another step that should facilitate growth is the introduction of well thought regulations so that investors confidence in the financial markets such as the stock market and the derivative markets is restored and more people come back to these markets with investments.
In terms of the fiscal policy governments should look to generate revenues from non-tax sources such as privatization campaigns or research and expenditure in to natural resources. Development of facilities and other industries in the public sector which can generate funds for the government for example tourism, both domestic and foreign, investments from abroad and so on.
Government expenditure is absolutely a necessary part of the solving equation. By spending in the right sectors, growth-oriented, government can really stimulate growth and create jobs. This is an important aspect because money spent by governments allows other businesses to generate revenues and create even more jobs in the economy. An added advantage is that infrastructure is either developed or upgraded. This also indirectly facilitates businesses by giving them a supporting environment to grow in. We also see a situation where governments should put taxes and raise revenues from the public. For instance governments worldwide should tax bankers more than other sectors because they stand to gain from the performance of other businesses. Therefore bankers bonuses should be subject to greater tax rates than bonuses to other executives in other industries.
Importance of Low Levels of Cost of Borrowing
As we see that benchmark interest rates continue to fall in major economic zones and countries what we understand from this fact is that when interest rates fall businesses and financial institutions find it cheaper to lend and borrow money. This situation is created by governments to stimulate businesses and entrepreneurial ventures. The important distinction that must be made here is that the availability of credit at such low levels should be for businesses rather than sub-prime borrowers who are either consumers or businesses. Banks should be encouraged to lend out to those businesses which are either new ventures or businesses that promise to expand and gain market share quickly.
Low levels of interest rates also can lead to an expansionary fiscal policy as governments find it cheaper to borrow from their central banks. This leads to a rise in government expenditure and higher debts for future governments to payoff. Low level of interest rates also lead to comparatively controlled level of inflation in a particular economy. For instance if interest rates are low in an economy then businesses would not need to increase the prices of their goods and services compared to an economic environment where interest rates are higher. The higher the interest rates the higher the level of price rise for consumer products.
The governments must understand that to fight off this monster crisis both fiscal and monetary policies must be used simultaneously to restore economic growth. Businesses must be facilitated and supply side policies also need to be improved upon. For instance better education systems, improved rail networks, and better quality communications network can go a long way in supporting the business environment of a country and the ability to generate entrepreneurs and new ideas for the future.
Conclusion
The idea of a perfect financial system and a sustainable world economy is far from achieved even with the introduction of new financial regulations and systems the fact of the matter is that as economies enter this new after-recession era they are in a reset situation as a lot of previous assumptions have changed. For example businesses now will be more cautious before borrowing from banks for new product ventures, banks would develop tighter products for the sub-prime market and governments would regulate markets and complex securitized products with greater scrutinized mechanism. All in all the future requirements and basic standard operating procedures will change and companies will need to adapt to those.
In terms of the financial sector the role of governments will increase immensely as they would want to protect the depositors and other stakeholders so that few bankers do not risk major crises such as the liquidity crunch which introduced this current economic crisis. Secondly, banks across the globe will develop systems and procedures which will isolate them from the losses incurred by other banks this might mean limited buying and selling of products and services amongst banks and financial institutions.
What governments must realize is that their actions today will impact future generations and therefore they must act responsibly to ensure sustainable levels of debt and the return of market economy and market factors to all the markets and industries of the world. Governments must not look at all the ailing industries and try to give them a stimulus package because that wont solve the problems of businesses in the long-run rather they would reduce the ability of businesses to stay on their feet and continue to growing and creating new jobs.