debt, gdpA country cuts spending and/or raises taxes in order to close a budget deficit. If that action causes a recession in the short term, does this necessarily damage the country’s net position (debts vs ability to finance them)?
For example, if a 5% GDP deficit is closed (suddenly) and that causes a recession with a cumulative drop in GDP of 5% over two years before a return to trend growth, the country’s net position would still seem to have improved: its debt is 10% lower than if the deficit had not been closed and its GDP is only 5% lower. Admittedly GDP is lower indefinitely, but so probably is debt because had the deficit not been closed, debt would continue rising at 5%.
The performance of any macroeconomy can be examined in terms of the short run (booms and recessions) and in the long run (growth and development). There can be spillovers from the former to the latter and vice-versa.
A recession is a temporary slowdown of economic activity that may or may not be associated with a structural change in the economy. If such occurs then it is likely that the growth rate in the future be higher. This, in a nutshell, is Joseph Schumpeter’s argument in favor of what he called Creative Destruction.
In short, what matters most (according to the work of Nobel laureate Robert Lucas in his work Understanding Business Cycles, and the Welfare Cost of Business Cycles) is growth. The media tend to obsess with unemployment, downturns and the like, but in terms of our personal welfare over the long run, economic growth trumps all. Using one of his most famous quotes, and paraphrasing a little, “Once one starts to think about economic growth, it is vcery hard to think about anything else.”.
That is why economists should give such a major importance to structural reforms, that aim to make the performance of the macroeconomy more robust, more efficient and more in tune with a more globalized economy. Note that in this line of reasoning microeconomic reforms such as ensuring more competition are crucial.
In short, it’s not only the quantity of growth that matters, it’s also the QUALITY of growth. China will probably reach this conclusion very soon with its oversized and underused real estate that has just been going to enable China to keep posting great GDP growth numbers year on year.
Don't be fooled. Recessions are bad and should be fought. Here is a cogent response to "liquidationism"
Call it the overinvestment theory of recessions, or "liquidationism," or just call it the "hangover theory." It is the idea that slumps are the price we pay for booms, that the suffering the economy experiences during a recession is a necessary punishment for the excesses of the previous expansion.
The hangover theory is perversely seductive--not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.
Powerful as these seductions may be, they must be resisted--for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality--with policies that encourage people to spend more, not less. Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression--with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply.
Recession can lead to deflation in extreme cases, which is a bad situation. Consider reading my blog post to clear my point.
A deflation may seem like a good thing in the eye of an average consumer, it can lead to collapse of any economy to the ground. As most economists say a hyper-inflation is always better than deflation, because deflation is almost impossible to control unlike hyper-inflation. For example, interest rates can be decreased, but there's a limit to it, you can't have negative interest rates.
Thus it's important to avoid recession at all cost. Though sometimes it works as a buffer or generally a correction for next upward trend in the market.
First, I think that using subjective terms such as “bad” or “good” causes immediate problems. The target outcome needs to be defined properly to use such terms. So given your extra statements, I’m assuming you mean can a society become more prosperous due to a recession. But please, correct me if I’m wrong.
So given that, one important detail is that all recessions are not equal. Some bubbles bursting can have only small effects on the society overall. I do feel that government intervention helped with the dotcom bubble, but that was a small sector of society with a lot of investment. It didn’t have the possible span of the the housing bubble. Basically, are we looking at a short or long recession. Is a double-dip likely? Are we facing a liquidity trap? If it’s a small recession, then it will likely clear out the weaker businesses and consumers can feel more confident in the surviving businesses (think about the oh-so-pointless websites in the dotcom era). However, if it is severe enough to result in a vicious cycle of high unemployment, low consumption such as the Great Depression, then it will likely not result in anything good. In fact, it can hold an economy back from prosperity that it would otherwise be capable of achieving.
However, I see no evidence that these are controllable aspects of a recession. Rather, these are characteristics of the cause, and for that reason aren’t really exploitable. Good things can certainly arise from a recession, but getting a good case of chicken pox when young can also make sure you don’t get a deadly case when older. Still it might be better to never have to deal with chicken pox at all. And many of the ‘benefits’ of a recession can likely occur without the recession.
One has to consider the opportunity cost of a recession and the long-term costs/benefits of a recessions.
A recession usually leads to a lower employment and lower economic growth. Although unsubstantiated by scholarly literature, I would argue that for common people a 5 to 10-year recession may mean that the course of their entire lifetime is different from what could have been if there was no recession. This is particularly true in developing countries where people have limited flexibility in changing their career paths. Therefore, deliberately causing a recession seems to have very negative repercussions.
The assumption that one must make about the positive effects of recession is that the government is able to implement structural reforms during the recession that would lead to higher economic growth later on. This has happened some times in the past. For example, India opened up its economy starting in 1991 after a debt crisis. This was not exactly a recession, but an economic crisis nevertheless. Some other examples can be found in this article titled "[Recessions are] Permanent or Temporary?". One can see some countries having higher GDP growth a few years after their recessions.
However, one can expect that usually structural reforms are difficult to implement during a recession, particularly in a democracy. During a recession, people want short-term respite rather than long-term benefits, and governments are most concerned about their performance till the end of their terms.
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