Lecture 3 - Baby-sitting & Great Recession (2007)

[Lecture 3: Baby-Sitting and the Great Recession: Why do we have a recession at all?] This lecture is closely related to Krugman Ch.1 A definition: The Business Cycle: The movement of GDP around the trend growth line. In general, if GDP is growing then we are in the boom part of the cycle, while...

[Lecture 3: Baby-Sitting and the Great Recession: Why do we have a recession at all?] This lecture is closely related to Krugman Ch.1 A definition: The Business Cycle: The movement of GDP around the trend growth line. In general, if GDP is growing then we are in the boom part of the cycle, while if GDP is contracting then we are in a recession. This can be seen in the following diagram: GDP Change 1956-2018 (2^nd^ quarter) (Note- we have missed out the Covid Pandemic!) The business cycle is important in economics because some important economic indicators are linked to the cycle. Unemployment increases during recessions as do government budget deficits. By contrast inflation tends to be lower while the trade deficit (Imports of goods and services minus exports of goods and services) tends to decrease as well. - Import-export - Import goes down and export remain the same = decrease Recessions are a serious social and political problem because: a\) Unemployment- this is directly linked to increases in crime, poverty and physical/ mental illness. b\) Pressure on families and society resulting from lower wages, fewer opportunities and unemployment. Leads to social unrest and the breakdown of families. c\) Pressure on political structures as a result of perceived economic failure. Rise of extremists to challenge traditional order. d\) Long-term degradation: Unused machinery decays so the economy loses capacity. Long-term unemployed lose skills, motivation and knowledge. Society as a whole poorer. Creation of an underclass of long-term unemployed trapped in poverty and unable to compete in the jobs market. [Why do we have recessions?] Recessions are odd occurrences because: There is excess capacity in terms of factories/ workplaces producing goods or services. There are also workers who are willing to work to produce goods but are unemployed. So: both the capacity and the workforce exist to produce those goods. Consumers also want to buy these goods if they have sufficient income. This income, in turn, could be generated by more workers being employed and earning more money. Why can't this problem be sorted out? This module will take a view (similar to the course text: Krugman) that was initially put forward by the economist John Maynard Keynes in his book: "The General Theory of Employment Interest and Money" (1936) [Krugman's baby-sitting cooperative] This is a real-life example in p.13-20 in Krugman. Ananlog for Workers, consumers and money Note that this acts as an *analogy* for the economy as a whole. It is interesting because it is a model economy that allows us to see how the real economy works by stripping away unimportant parts. The baby-sitting cooperative was one that was active in the 1970s and was mainly used by congressional employees on Capitol Hill in Washington DC. The cooperative consisted of roughly 150 young couples who would baby-sit each other's children. This is difficult to coordinate- how can you make sure that members of the cooperative actually contribute baby- sitting time and don't free-ride on the system? The answer was by issuing coupons which entitled the bearer to one hour of baby-sitting time. When a couple wanted a baby-sitter for their child then they would spend the coupons by asking others to baby-sit. There was no time limit on coupons so coupons could be saved up for when they were needed. This may seem innocuous, but it was to present a severe problem for the cooperative. At some point the number of people who want to save up coupons and acquire more overtook those who wanted to "spend" the coupons. However, if there are few people spending coupons then the chance of earning more coupons diminishes. If people are short of coupons, they will snap up baby- sitting opportunities when they can, leading to further shortages. This is because they expect future shortages and hoard coupons to offset this shortage. Inevitably, the system started to break down as there were fewer and fewer coupons in circulation to meet the needs of those who did want to employ others as baby- sitters. The result was that there was insufficient baby-sitting Let's look at the analogies here: The members of the cooperative are analogous to workers (babysitters) and consumers (people who go out and employ babysitters) in the real economy. Coupons are equivalent to money. Workers earn coupons as income and consumers spend their earned coupons. Members can save their coupons in much the same way as we save money. The amount of babysitting can be seen as equivalent to GDP. Members in the above situation want to work (babysit) but cannot- so they are unemployed. Meanwhile consumers (people wanting to go out) have not enough spending power to employ as many babysitters as they wish. This is analogous to a recession. What has gone wrong here? Essentially there is a *coordination failure*. The desire of people to save does not match up with the necessity to keep spending. Related to this is the *paradox of thrift* This is a problem with saving in general. For an individual, saving is good- it allows one to build up large sums of money that can be used for investment, saved for a rainy day or for potential future purchases. However, if one saves, one is not spending money. It follows that if *everyone* increases their savings then *total* expenditure is reduced. Reducing total expenditure reduces the amount that can be spent on goods and services which reduces output and results in the unemployment of those who are producing this output. How was this problem solved? The baby-sitting recession was resolved by issuing more coupons. With larger numbers of coupons available, the shortage was resolved, members were able to spend their coupons while being more relaxed about saving to cover future shortages. This also has an analogy in the macro world. If one issues more money into the economy then this quite often results in a recession coming to an end as more money means more purchasing power that can be used in consumption and investment. The equivalent of a "coupon- issuer" in the macro-world is the central bank (In the UK, the Bank of England, in the US the Federal Reserve, in the Euro-zone, the European Central Bank). After the start of the "Great Recession" in 2007 there were frequent attempts by the central banks to do just this. This was called *Quantitative Easing*. = printing money This is a type of *monetary policy*.