Friday, August 24, 2007

Why America Should Have a Recession

While today's reports on durable goods orders and new home sales were relatively bullish, most other reports still indicate a weakening U.S. economy. And the credit crunch this month likely implies that reports for August and September will be a lot weaker. Which is why I still think it is likely that America will fall into a recession this year.

But beyond the descriptive issue of whether America will have a recession or not is another, perhaps even more interesting, discussion. Namely the normative discussion of: should it have a recession?

What kind of question is that, you might ask. Recessions means that production falls and unemployment rises which makes people worse off, so of course recessions are bad.

Well, all of that is true, but it misses the point. While it is not good that the need for a recession has been created, it may just be the case that under the circumstances, a recession is a lesser evil compared to not having a recession.

The Economist, who for long has been my favorite among established magazines, not least because it very often implicitly or explicitly argues for Austrian economic theories, argues this case in its latest issue.

It points out that recessions are processes which weed out inefficient firms and forces a reduction in imbalances. Case in point is the massive counter-cyclicary
policies of Japan in the 1990s which while being successful in avoiding a steep recession/depression, created a nearly permanent stagnation. Another example is in fact America, who despite the positive supply boost from Bush's tax cuts and the housing bubble actually had relatively moderate growth during the recent business expansion, and who will now likely suffer the hang over from the housing bubble.

As the article points out, sometimes downturns get out of hand and get more severe than they need to be. This was certainly the case in America in the 1930s when massive bank failures created a significant monetary contraction. But as long as the recession is the result of the end of monetary inflation, rather than outright monetary deflation, then recessions are a necessary evil to purge out the wasteful excesses of previous inflationary booms.


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