The Recession: Causes and Cures

3079
the-recession-causes-and-cures

The present recession is the direct consequence of first, the formation and then the bursting of speculative asset-price bubbles in the housing and financial markets, made possible by a combination of three factors. An excessive growth of liquidity in the financial markets was tolerated by the central banks,  the Federal Reserve and the Bank of England. The behaviour of these two bodies encouraged the development of two significant beliefs amongst financial market players:  that debtors would always be bailed out by the increased availability of cheap money, and the belief that many financial institutions were too big  to be allowed to fail. The combined effect of these three factors was to encourage behaviour on the part of market participants that ranged from the reckless to the fraudulent. Lesser contributory factors included the failure of regulatory agencies to identify, let alone restrain, such behaviour, and the pressure exerted on the commercial banks by Governments in both countries to make extensive housing loans to households who were poor credit risks in the name of ‘social inclusion’.

Those who were in charge of the commercial banks and other financial institutions  that failed have, rightly, either resigned or been dismissed. No one would entrust them with the responsibility of leading the recovery of the institutions they made bankrupt. However, no such principles seem to apply to those policymakers who were responsible for the systems of monetary control and financial market regulation that failed so spectacularly in both London and New York. These failures may be attributable to the fact that the policymakers concerned were relying on an inadequate understanding of how recessions come about, and how financial markets behave. Their variable and sometimes contradictory responses seem to bear this out.

Just as there is no medical way to escape a hangover, other than to avoid becoming drunk, so the only way to avoid having a recession is not to have the antecedent boom. There may be, however, some ways to mitigate the worst effects of a recession. The key principle must be to encourage the restoration of a climate of confidence in which businesspeople can seek profitable opportunities. The most direct way in which a government can bring this about this would be by a permanent  reduction of taxes on business. To be effective, this must be financed, not by increasing borrowing and thus future taxes, but by cutting unnecessary government expenditure.