How to Fix an Economic Crisis

How to Fix an Economic Crisis

During an uncertain situation such as the beginning of the coronavirus pandemic, people would tend to save their wealth, they would have to stay at home, and many people would lose their jobs. This trend would lead to fewer transactions in the economy, businesses would make less money, more people would be unemployed who could then spend less money, and the vicious cycle would continue. It would cause deflation and thus hinder the economic activity of an economy more.

Monetary Policy

The central bank would need to prevent the deflation as they work toward keeping a stable inflation rate. The central banks would lower the interest rate and create more money in the form of debt. So, people would have more access to money as banks would lend more. In turn, there will be more transactions in the economy, which would increase demand. Thus, the inflation rate would go up. However, it is slow to act.

Fiscal Policy

The government has more influence over the economy and fast-acting tools to influence it. The government could lower the taxes and choose which taxes to lower (as there are hundreds of taxes to choose from). For example, they could reduce taxes of specific businesses that would perform poorly at this time. Another thing is that it is fast-acting. Say the government reduces the income tax, then people would feel the extra money from the next paycheck. Alternatively, it can directly hand out fiscal stimulus, in the form of cash, to people. These actions would highly motivate people to spend more. More spending will mean more people would have jobs, they would have more money to spend, and the cycle would continue. This phenomenon is called the multiplier effect.

The government can also inject more cash into the system through infrastructure spending stimulus. By spending on infrastructure also gets money in people’s pockets and has the added benefit of having something of value in the end. However, the multiplier effect is not that strong here, and the benefits are slower to appear.

Crisis on Supply

In this pandemic, the problem is not only the lack of money to buy things, but it is also the shortage of supply. As every country had to be in lockdown, most businesses shut down, and people have to stay at home for the safety of selves and everyone; production was significantly hindered. So the governments have to shift their focus from the inflation rate to keep businesses alive. They can help businesses through loans, bailouts, grants, and other ways.

Moral Hazard

Major corporations are too big to fail, and they know that. They employ tens of thousands of people and provide services crucial to the economy. Their goal is to maximize profits for the shareholders in the short term. During a boom, they could save money in an emergency fund. However, money sitting around would not be profitable. They rather spend on share buybacks to inflate the price of the company on the stock market or spend it on more profitable ventures. They do it because they do not need to. For example: after the subprime mortgage crisis, major banks around the globe were bailed out by governments. The businesses which want to be ethical would become uncompetitive and be forced to act along with the industry standards. So, the governments must find a way to maintain the services those businesses provide and also punish the shareholders and executives that facilitate this reckless behavior.

Conclusion

No government can completely control the economy; it can only be managed. They have to understand the tools they have at their disposal and use them properly. If they can maintain the stability and confidence of the people, everything will return to normal.

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