Could Governments spending money pull economies out of recession?

Economy Jun 21, 2021

It is not unknown that post the COVID-19 pandemic, economic recession, and hyperinflation are going to be the problems that a lot of economies have to fend off. Why, you ask? Because the governments around the world have been on a spree of making economic reforms, announcing relief packages, and printing more currency notes to fight economic slowdown caused by the lockdowns. To help you understand hyperinflation, and how to worsen it, here is an example from Zimbabwe.

In 2008, Zimbabwe recorded a daily inflation rate of 98%, which means the cost of goods and services doubled every day. One of the major reasons for this was the excessive printing of money in the country. Whenever there are excessive currency notes out in the market (supply increased), its value falls. In November 2008 Zimbabwe recorded an inflation rate of 79,600,000,000%. But one might think Zimbabwe is a fundamentally weak economy, and while that is true, a similar trend is being seen in the world’s largest economy (by nominal GDP), the United States of America. 35% of all the US Dollars in existence were printed in only 10 months (Feb 2020 to Dec 2020).

Now that we understand the nature of the problem, how does one solve it? The answer to this question was given by John Maynard Keynes during the Great Depression, an economic recession of global magnitude. While traditional economists believed that the global market attains equilibrium on its own, and government interference might delay this process, Keynes suggested that increasing government expenditure and lowering taxes will help restore the demand in an economy. Other economists suggested that owing to the recession, investors, venture capitalists could capitalize on opportunities with low risk, and that would help bring up the equilibrium in supply and demand in the market so that the market will balance itself as it always does. Although Keynes knew that the market would eventually balance itself, nobody knew how long this would take without any intervention, and hence Keynes came up with what is now widely called the Keynes’ General Theory.

At the heart of Keynes’ General Theory is the multiplier effect. Let me give you an example to explain the multiplier effect. Let's say the government has Rs. 1000 crore project that concerns building a dam, or a public building. Let's also assume that Rs. 500 crores out of the total budget are dedicated to labor costs. These workers would then take a considerable amount of their salary from the government project to buy goods and services from local businesses and traders. This exchange would further help the local businesses to hire workers for their own trades, thus throwing in the capital in the market and helps it gain balance faster. For every one rupee spent by the government generates well more than one rupee in economic growth. A lot of economists, however, have criticized the multiplier effect and called it fundamentally flawed, because it does not take into consideration the debt on a government due to public expenditure, not to mention the rise in taxes to pay off this debt.

Despite the various criticisms to Keynes’ theory, the most promising method to get economies back on track would be the government and private individuals working together to generate jobs. Governments could undertake huge public projects, but private individuals could pay the people more handsomely for such projects. Privatization of sectors where the government does not hold expertise in managing and nurturing the projects could help bring balance to the market and dwindling economies suffering from hyperinflation.

This article has been written by Rutik K. Jadhav for The Paradigm

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