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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: TobagoJack who wrote (5697)	7/7/2001 4:04:16 AM
From: smolejv@gmx.net	Respond to of 74559

supply-side vs demand-side recession: prudentbear.com The author is discussing the UK situation. However, the arguments apply in a very discomforting manner to US as well. QUOTE In typical recessions of the past 50 years, central banks have had to restrain demand and incipient inflationary pressures through repeated interest rate rises. The worst that can generally happen if the central bank goes too far in this process is that the recession becomes more severe, but this can usually be offset ultimately through aggressive monetary stimulus to avert a total collapse in aggregate demand. This turnaround, however, is not as easy to achieve in a downturn characterised by oversupply brought on by excessive capital investment (particularly if financed with large quantities of debt which is the case today in both the UK and the US) because the tools used by the central banker (i.e. rate cuts) are generally more appropriate to restoring aggregate demand, rather than solving the problem of excess capacity. A fall in capital expenditure in the aftermath of an investment boom is generally not averted by cuts in interest rates; rather it is the lack of profitability on existing assets generated by excess capacity that forces plans to be cut back until output comes back in line with underlying demand and profitability can be restored. But here is where the problem of the fallacy of composition comes into play. Managers whose profits are falling rapidly, for whom labour usually comprises a large proportion of their input costs, will take any such rise in their cost of capital to lay off even more workers in order to cushion the negative impact of falling profitability. If just a few companies lay off workers, they can maintain profit margins by reducing costs in the face of sluggish demand. However, if all managers lay off workers, costs in the aggregate might fall, but demand falls even more rapidly as the unemployment that accompanies layoffs further destroys consumer confidence and inhibits spending, particularly in countries like the UK, where household savings rates are so low and debt levels are very high. The risk of debt deflation dynamics becomes greater. UNQUOTE dj