Wednesday, September 5, 2012

Blame the fool in the shower!

Good morning everyone. A lot of people ask me on a daily basis to explain the meaning of a recession and provide reasons as to why the economy cannot bounce back. The reason is simple. We blame the fool in the shower. Allow me to explain.

A recession as I have already mentioned in a previous post, is a persistent decrease in the total production of a country resulting to higher unemployment, lower wages and decreased total (aggregate) demand. As a result we observe longer lines at the unemployment office and there is a sense of insecurity in the economy. In other words this is what we are experiencing around the world today.

Whose fault is it that the economy cannot bounce back? Well it is this guy's fault.
Have you ever taken a shower and got "burned" while trying to adjust for hot water? What did you do next? You turned the cold water up and as a result you felt as if you were standing naked in the middle of Alaska. This is what Milton Friedman, the father of monetary economics, described as the "fool in the shower".

The analogy to economics is that when employing economic policy to battle a recession, governments are usually met with 3 types of time lags. The recognition lag is the time it takes for the policy makers to identify that the economy is in a recession. The decision lag is the time it takes to decide on an appropriate economic policy to battle the recession and the implementation lag is the time it takes for a policy to be implemented once it is decided upon.

As a result of these time lags, the economy is no longer in the same state that it was initially when the process was initiated. The outcome in the end may not be the desirable one and in contrast it may even have the adverse effect and make the situation even worse.

Have a nice day and be careful when taking a shower!

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