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Economy

The Double Dip

President Ronald Reagan appointed 376 federal ...

Authored By Arnab Sinha:

If you are a real foodie and exotic desserts like chocolate dipped strawberries or honey dipped nachos make your mouth water, then the title of this story might just sound like a gourmet delight to you. Well, I am not a food connoisseur (and my cooking acumen is only limited to the genre of instant noodles and ready made pastas), but what we will be discussing here might make your jaws drop, because this is a recipe of a disaster in the making, and it might just be coming our way.

 

The double dip is the new fancy word economists around the globe are using to describe the possible shape of the recession we entered into.A double-dip refers to a recession followed by a short-lived recovery, followed by another recession.After a slew of sustained low grow, while global economies are trying to limp back to normalcy (as I write this article, Sensex is at a 32-month high), the million dollar question is will the recession haunt us again and hence, will we again go into the second dip?

To begin, lets try to understand, what were the steps taken post the 2008 recession (i.e the first dip) and what effect they had on the economy. The knee jerk reaction was to dole out large fiscal stimulus packages to offset the reduction in private sector demand caused by the crisis. The U.S. executed two stimulus packages, totaling nearly $1 trillion during 2008 and 2009. The US government announced historical ‘Troubled Asset Relief Program’ (TARP) by which they purchased assets and equity from financial institutions to save them from delinquency. European governments followed suit. Stocks of the world’s most well known companies- Citigroup, Bank of America, Goldman Sachs, Wells Fargo were bought by the State. And financial jargons like bailouts, capital replenishment, stabilization etc made a silent entry into our coffee tables.

Now all the above policy changes were implemented with the broader objective of bringing the economy back into track. So naturally one would ask, so what is the fuss all about? Why should we again get back into another recession? Recollect, that we said US alone pumped 1 trillion dollars in rescue packages. Where did this money come from? More debt, of course! Again, is that risky? The easy way to think of it is – suppose you are in a debt trap – you cannot pay your credit card bills and neither have the job that can pay off your education loan. And you are instead taking another loan to pay off your pending obligations. Monetary economists believe that spending on a stimulus packages- funded by additional government borrowing- is ignoring the bigger picture. The burden of that borrowing would fall on young people and future taxpayers. Federal policymakers are leaving a terrible fiscal legacy to the next generation, and a stimulus package would only make matters worse. Of course, the policy makers advocating stimulus packages have their reasons to believe otherwise. US Government, for example, drew up some statistics to show that every $1 pumped will generate $ 1.57 into the economy (a whopping 57% return on every penny invested with the bailout money). However, the basic assumption of this calculation is that every dollar that gets into the pocket will be spent. What if you, being an intelligent investor, foresee that tomorrow the government will tax you more (after all, that’s how they will pay off the debt- that funded the stimulus)? You will figure out that it makes sense not to spend the income gain you have now and rather to save for the future. And then you don’t invest and the 57% return as claimed will never happen. Stimulus package will therefore never promote a sustainable economic recovery. A classic recipe for the double dip!

Another tell-tale sign of the double dip happening is the recent phenomenon of inflation going over the roof. Now until and unless there is some productivity changes to boost the supply side factors, the only way left for the policy makers to cool inflation is to raise interest rates (note how many times RBI has done that in recent times). High interest rate will act as an incentive to park more money in banks and will suck up the money supply in the economy. The value of money will rise and inflation will go down. While that may counter inflation, high interest rates will hamper investments and economy can further dip back into another recession.

All said and done, you will ask me how we would we know that recession is back. Will we again wake up another morning with the tabloids screaming- XYZ files for bankruptcy and the likes? And how will we understand whether we are heading into recession or is it the more long-lasting and lethal variant- the Depression- that is in our way? To be honest, I don’t have the thumb rule for that. But in case you want to refer to former US president Ronald Reagan, “Recession is when a neighbor loses his job. Depression is when you lose yours.”

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