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A Central Bank’s Toolkit to fight a Depression

By Ted Peroulakis

I know as you read this, you are aware that America and the world are currently experiencing an economic crisis.

Many economic experts say we could be heading towards a worsening recession or even a depression.

In this article, I have listed a few tools that a government has at its disposal to pull itself out of a recession and even avoid a depression.

It’s good to be aware of the intervention tools governments use to prop up an economy in order to better protect your wealth and purchasing power.

Listed below are the major government intervention tools:

Inflation

Inflation refers to a sustained increase in the general level of prices for goods and services.

As inflation rises, every dollar you own buys a smaller percentage of goods and services.

The government can pull out of a recession and avoid a depression by printing up lots of money and spending it.

The extra cash in circulation raises prices.

The purchasing power of people’s money is going down with inflation so they are encouraged to spend more.

People will buy real assets that are worth something instead of watching their cash lose its value.

This extra spending creates jobs, and pushes business expansion.

But, inflation has its negative side effects.

For example, it is difficult for businesses to anticipate the cost of raw materials, the cost of labor, or the prices for their goods and services.

It difficult to determine what price a business will have to charge to make a profit.

Keep in mind that governments would rather resort to inflation than have another great depression.

Credit Policy

Credit Policy refers to the policies banks and financial institutions follow before granting loans.

The world’s central banks and finance ministries are attempting to stimulate credit, but it is still hard to get a loan these days.

One way to encourage lending is to insure loans with government insurance policies.

Banks and financial institutions will be happy to loan money to businesses and consumers if the loans are backed by a government guarantee.

If businesses are able to borrow money easily, they are more likely to invest in new projects and hire new employees.

Monetary Policy

Monetary policy refers to the regulation of the money supply and interest rates by a central bank, like the Federal Reserve Board, in order to control inflation and stabilize its currency.

The government can use monetary policy to impact the economy by influencing the effective cost of money.

In effect, the government can influence the amount of money that is spent by consumers and businesses.

A central bank could buy up government bonds and shorten the duration of the safe assets that investors hold.

This causes the price of safe investments to rise, which encourages businesses to invest back into their business instead of paying out dividends.

This can pull people out of unemployment and encourage business expansion.

Quite a bit of monetary policy intervention has already been going on around the world and hopefully this will have a positive impact.

Fiscal policy

Fiscal policy is the means by which a government adjusts its levels of spending in order to monitor and influence a nation’s economy.

Just borrow more and spend more; thereby creating jobs and encouraging business expansion.

The government could decrease taxation, giving consumers more spending money while increasing government spending by building things like roads or schools.

This creates jobs and wages that are pumped back into the economy.

Conclusion

So now, you see that a government can use inflation, credit policy, monetary policy and fiscal policy to head off a recession or a depression.

Keep in mind that none of these intervention tools is perfect without consequences or side effects.

It looks like the Obama administration and other world governments are on the verge of expanding government intervention to try to rescue the global economy.

Best Wishes,

Ted Peroulakis

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Editor’s Note: Ted is absolutely correct, these are the tools available, but unfortunately even with all of these tools at their disposal the government is often powerless to prevent a Depression.

Often, contrary to popular opinion, Government intervention is actually what turns a Recession into a Depression.

In the words of Dan Denning of Whiskey and Gunpowder,

You can only get a depression when the government and the monetary authorities take unusual steps-driven by political motives-to prevent the natural process of recession. This is why today’s policy moves are setting us up for a Depression…

 And it’s not the first time.

It’s widely believed that the Great Depression had its origins in the slow response of the Fed to the banking collapse that followed the stock market crash. That failure, so the theory goes, was followed by too little fiscal innovation and government spending by then U.S. President Herbert Hoover.

But all of that claptrap is exactly wrong, we humbly suggest. The Depression was a foregone conclusion the minute the business cycle was hijacked by manipulation of the credit cycle. A recession is natural. A Depression is always man-made.

In our Article Jaguar Deflation, Robert Prechter agrees saying, I am tired of hearing people insist that the Fed can expand credit all it wants”.  Prechter takes it a step further and says that the entire boom bust cycle is caused by government meddling.

 

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