Tuesday, June 26, 2012

In simple words, what is a Recession and who is the Troika?

Good morning economists! We have all felt the impact of the current recession, each one of us at a different level. We hear the words "recession" and "troika" thrown left and right but believe me only a few know their meaning. We have felt the recession, but what is it?

A recession is when production in a country decreases for more than 6 months. It is in other words a prolonged condition. Because of decreased production, employment also decreases and more people are left without work. As a result, households have less money and thus they consume less goods and services which in turn causes the firms to produce even less. This cycle continues for an unspecified period of time.

There are four ways to combat a recession. The first, proposed by John Maynard Keynes, is to use the government budget to lift the economy. This can be done by increasing government spending and/or reduce taxes. The second way is targeting supply and the argument is that reducing or abolishing corporate tax can cause firms to produce more and hire more people. The third way is to decrease interest rates, so that borrowing and investment increase thus having a positive impact on production. Finally, the fourth way is to do nothing. Allow the economy to balance the markets itself and get out of the recession on its own.

The problem with the current recession is that governments cannot react by using any of the tools described above. Most of the world governments already have a budget deficit, meaning that they spend more than what they receive as income. In fact, they have been borrowing money for some time now. So they find it impossible to decrease taxes as this would immediately decrease their income which is needed to pay off their debts. Lowering interest rates may be a solution, however, investors have lost confidence in the financial system and banks face liquidity problems. Simply put, there is not enough money to lend!

This is where the Troika comes in. Troika comes from the Russian word three. Three entities that have the responsibility to monitor the economies of countries that ask for monetary help from the European Union. These are the European Commission, The European Central Bank and the International Monetary Fund.

Troika's main aim is to impose strict economic policies for the country that requests assistance, by cutting government spending, increasing taxes and reinforcing the financial system. The problem, however, is that these policies push the country into a more severe recession in the short run because production declines even more due to a further decrease in consumption and the effects are usually felt by the lower income groups.

Have a nice utility day!


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