Saturday, December 26, 2015

Recession as a Monetary Phenomenon

Recently, Nick Rowe explained that recessions need a strictly minimalist model in order to work well for general equilibrium:
Recessions are not about output and employment and saving and investment and borrowing and lending and interest rates and time and uncertainty. The only essential things are a decline in monetary exchange caused by an excess demand for the medium of exchange. The rest is just embroidery.
Why, then, does the "embroidery" get confused with what is most important - especially in the moments when supply shocks are most evident? For one, recessions can have multiple connotations. A quick Google provides the more technical term, i.e. the one which matters most for policy makers in terms of response:
1) A period of temporary economic decline during which trade and industrial activity are reduced, generally identified as a fall in GDP in two successive quarters.
Strictly speaking, a statistical (technical or cyclical) recession needs to be dealt with solely through sufficient monetary representation. As to supply side and structural concerns which may affect ongoing conditions, Investopedia provides a less technical definition - one which indicates how an economic decline may "feel", in spite of statistics or technicalities:
 A significant decline in activity across the economy, lasting longer than a few actual months.
...and months can seemingly drag into years. One reason the latter concept of recession has become relevant, is the slowdown in long term growth, worldwide. Just the same, the Fed does not serve any productive purpose by stressing economic circumstance which lie outside of its control. Doing so is also problematic, insofar as policy makers use the general idea of recession in ways which sometimes allow them to thwart accurate monetary representation.

Were it not for the fact that central bankers are responsible for both financial concerns and monetary aspects of the economy, the role of accurate monetary representation would be more obvious for all concerned. As to transparency: If supply side factors could be thought of as curtains over a window, financial activity - when confused with monetary activity - would be the heavy drape which is capable of cutting out all the light.

A lot of confusion could be put to rest, if it were better understood that recessions - in the strictest sense of the term - are a monetary phenomenon. This means that when an excess demand for money arises, the Fed's primary responsibility is to meet that demand, instead of using supply side factors as means to confuse the public regarding what is at stake.

Perhaps most important, is that structural concerns are not so much the concern of the Fed, as of the individuals who wish to take part in and contribute to the marketplace. The supply side factors which determine output and long term growth, need representation in the marketplace which goes well beyond the policy makers of the present. Otherwise, central bankers may only continue to create more financial burdens which limit long term growth.

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