The recent economic downfall caused by the COVID-19 infection that has rapidly engulfed the entire world is a truly drastic change that will have detrimental effects on the global trade and economic performances of multiple countries. In his article “Will Small Business Survive The COVID Recession?,” Richard McGahey (2020) tries to examine critically the opportunities that companies have in the current environment and the future development of organizations worldwide after the crisis. According to the assumptions offered by McGahey (2020), small businesses are unlikely to recover from the damage caused by the crisis with the current tools deployed, mainly due to the problems with the lending pipeline.
The author also approaches the optimism about the economic revival displayed by Donald Trump rather critically. The stance that McGahey takes is understandable given the implications of the current crisis for the aggregated supply and the threat of it slowly being exhausted as all production processes are put on hold (2020). The phenomenon of aggregated supply is the goods and services that a company can offer to its customers. Considering the problem closer, the author explains that it is not the fact of closing but the rapidity of it that makes the problem so difficult to handle. Namely, businesses have no time left to adjust and, instead, have to cease all processes without considering the expenses that the specified step will entail. Consequently, the physical capital as the total amount of physical assets that a company owns will inevitably become impossible to use and, ultimately, turn into waste. The author paints a rather dark picture of the future of the world economy, yet his concerns seem quite realistic to give the economic prognoses. Thus, McGahey (2020) warns that, for the global economy to get back on its track, a tremendous effort will have to be made once the COVID-19 issue is addressed.
Uncertain and unstable economic times can be the worst and most challenging environment for succeeding in businesses. Many companies start experiencing downturns, which soon result in the loss of jobs, reduced performance and income, and even going out of business. Nevertheless, just like damaging some organizations, a recession may also help companies survive competition, discover new growth opportunities, and thrive as a result of economic struggles.
Since the U.S. economy is rather unpredictable, it is essential for business owners to focus on generating ideas while staying powerful in their recession-proof industry and managing it smartly and strategically. The purpose of this paper is to discuss what products and businesses are likely to survive in a recession and base this consideration on individual behavior theory.
There are several industries that may be considered recession-proof due to the features of the products and services they offer. The main factor influencing whether a business survives severe downturns or disappears from the market is its necessity or luxury (Baye & Prince, 2014). In other words, a company is likely to thrive after experiencing economic struggles if it offers products that are always needed by the customers and typically preferred over other goods and services. Considering the varying needs and interests of Americans, what are these products?
For example, businesses in such niches as health care, food and beverage, repair services, baby products, and staple items are unlikely to disappear or have significant problems in and after a recession. Goods and services offered by these industries are not a luxury or one’s exceptional interest (Baye & Prince, 2014). That is why most people prefer them over other niches like entertainment, traveling, and others that they may relatively easily live without.
To support these assumptions, it is possible to refer to individual behavior theory. According to Baye and Prince (2014), “the budget constraint restricts consumer behavior by forcing the consumer to select a bundle of goods that is affordable” (p. 129). Consequently, if a person’s budget is restricted, they are likely to prefer necessary products and services over luxury ones, meaning that businesses that offer the primary goods have more chances to survive in a recession.
Changes in a consumer’s income may have two possible consequences. First, if the income becomes higher after being low, the customer may start buying more of the necessary goods or the luxury ones because they could not afford them before (Baye & Prince, 2014).
In both cases, the industries’ chances of surviving a recession increase. Second, if the client’s income reduces, then again, they are restricted by only the necessary services and goods, making it more likely for businesses in niches like health care and foods and beverages to thrive. What is more, if a company successfully incorporates various marketing schemes and sales techniques that make customers think they can save or benefit when getting a service or product, it is incredibly good for the business. Such approaches attract more clients and allow the companies not only to survive downturns but also become more productive and thriving.
To draw a conclusion, one may say it is essential to consider the mentioned factors when starting a business or going through a recession. The influence of consumers’ preferences, needs, and income levels is hard to overestimate when assessing businesses’ likelihood of surviving a recession. However, apart from depending on customers, it is also necessary for managers and leaders to be strategic, farsighted, and creative. Those businesses that offer primary goods and services and are led by professionals are more likely to thrive after downturns.
Reference
Baye, M. R., & Prince, J. T. (2014). Managerial economics and business strategy (8th ed.). McGraw-Hill/Irwin.
Recession affects all aspects of national output and has a negative impact on GDP, employment, real income, production output and other elements of economic activity. During 2008 and 2009, the recession occurred as a result of the banking crisis since these institutions did not have enough funds for lending. Bank lending decreased, leading to a subsequent confidence decline and liquidity issues. The leading indicator of recession in 2008 was the gross domestic product (GDP) decline. This paper aims to examine the effects of the 2008-2009 recession in the United Kingdom and define key macroeconomic concepts that relate to it.
Key Concepts and Events
Understanding the fundamental concepts of macroeconomics will help evaluate the causes and consequences of the 2008-2009 recession in the United Kingdom. The recession has several definitions, which emphasise different aspects of macroeconomics, such as GDP, employment, national output and others. According to Horner and Stoddard (2018, p. 30), the recession is “the period where actual growth is negative for two consecutive years.” A notion, which describes an opposite case is an economic boom – where the rate of growth is above average. Therefore, in order to examine the recession in the United Kingdom, it is necessary to evaluate the major macroeconomic indicators of growth.
The United Kingdom was not the only country affected by the recession, as it signified a prolonged period of negative growth globally. However, this paper will focus specifically on the economic impact of the recession on inflation, income and stability. Office for National Statistics (2018) assesses the critical elements of the United Kingdom’s economy ten years after the recession and states that the country was able to return to its previous GDP in five years. Initially, the economy decreased by 6% between 2008 and 2009. Current data suggests that the GDP has increased by 11% when compared to the pre-recession rates in 2017 (Office for National Statistics, 2018). Therefore, the monetary policy of the United Kingdom government helped successfully recover the economy after the recession.
By examining Graph 1, one can see the decline of GDP during the years of recession and a slow return of the economy to its pre-recession state. This graph is helpful because it showcases the rapid changes in the national output and the long-term effects it. It is due to the fact that all aspects of the economy suffer. For instance, the Office for National Statistics (2018) states that unemployment rates peaked since businesses did not hire new employees as a result of uncertainties. The policy that helped recover the economy will be examined in the subsequent sections.
Graph 1. GPB of the United Kingdom by quarters in 2008 (Office for National Statistics, 2008).
Inflation and Stability
Information rates are a critical macroeconomic indicator. According to Horner and Stoddard (2018), this term can be defined as a price change over a one-year period, calculated as a percentage. During 2008-2009, both the consumer price index and retail price index decreased across the United Kingdom. Notably, during a recession inflation rate usually decrease, which sometimes leads to deflation, as opposed to an economic boom, during which the rates increase.
Therefore, if the government were to impose policies for a rapid recovery of the country’s economy, inflation rates would increase significantly. This is connected to the increased spending of the people. In this context, it is essential to examine stability, which is an economic system with a minimal number of fluctuations.
Inequalities of Income
It is evident that the recession also had an impact on employment rates and income of the people in the United Kingdom. Heyes, Tomlinson and Whitworth (2017) state that in the period of the crisis, unemployment reached 8%, while in 2007, it was 5.3%. Currently, the rates continue to decrease, with 5.6% unemployed in 2017. However, this crisis has revealed several issues in the labour market, such as underemployment. This concept describes people who have to work fewer hours or take jobs that do not correspond with their education and qualifications, which leads to them receiving less income.
Inequality of income is a concentration of financial resources within a small percentage of the population. This concept usually refers to the disposable income of individuals, and there are several approaches to measuring it, such as the Gini coefficient. This measure suggests that the United Kingdom has the highest coefficient of income inequality when compared to other European countries (Income inequality in the UK, 2019; Coulter, 2016).
According to the report by the United Kingdom Parliament, “following the 2008 recession, there was a small fall in income inequality as higher-income households saw a larger fall in income in real terms” (Income inequality in the UK, 2019, para. 10). The primary reason for this difference in real earnings of high-income households and those with low income is a rapid decrease in real earnings. This occurrence is substantiated by Horner and Stoddard (2018), who argue that economic growth has a danger of increasing income inequality. Therefore, recession mainly affected the income of high-earning households in the United Kingdom, reducing inequality.
Causes of Economic Growth, Business Cycles and Reasons for Recession
Economic growth and a subsequent increase in GDP and production output can be a result of an increase in business activity in a country. This leads to more output in terms of goods and services. The business cycle describes the variance of the economy over time. This concept refers to fluctuations in growth, which repeat over time (Horner and Stoddard, 2018). The primary reason for recession, which arises from the definition of this concept, is a decrease in production output which occurs over two quarters.
In the context of the 2008-2009 crisis, the leading causes were connected to a large number of high-risk mortgages, which reduced the liquidity of banks. In general, as part of the business cycle, the upward and downward changes in the GPD are natural. However, in the case of the 2008-2009 crisis, they were caused by improper policies and mortgages that could not be repaid.
Monetary Policy
In the United Kingdom, the Monetary Policy Committee (MPC) is an institution that oversees the monetary policy of the country. The main scope of activity for MPC is the interest rate for short-term borrowings, which is the definition of monetary policy (Horner and Stoddard, 2018). Deleidi and Mazzucato (2018) state that the primary strategy, which helped recover the economy, was the Quantitative Easing (QE) programme, implemented by the Bank of England (BOE). The main objective of it was to stimulate lending for banks. However, initially, the approach was not practical since the demand for borrowing was low. Next, QE aimed to lower interests rates and purchase corporate bonds.
GDP
As was noted in the previous sections, recession and economic boom are two different indicators of growth or decline of the economy, which have to measured to determine the national output. For this purpose, GDP is used, which helps determine the level of production in a country. The economy of the United Kingdom, evaluated through GDP, has been steadily growing since 1992. However, since April 2008, it began declining, which was the first consequence of the recession.
According to the Office for National Statistics (2018, para. 1), GDP is measured by “adding up the value of all the goods and services produced in the country.” In the case of the United Kingdom, the country experienced five quarters GDP decrease, and as was examined earlier, two consecutive quarters are considered a recession. Therefore, GDP is an essential indicator since it helps determine the success of the economic activity.
National Income
In general, there are three key ways to measure national income, which are -product, income and expenditure. The first one refers to the final value of goods, and the second is the calculation of factor incomes, and the final is the overall spending (Horner and Stoddard, 2018). The first method refers to all wages received during a one year period, profits of businesses and interest received by landers or landowners. When applied to the recession, this approach allows calculating the flow fluctuations in finances received by individuals in the country. The second method accounts for all products and services across different sectors of the economy and allows assessing the decrease of output upon recession.
Finally, the third method is the spending of individuals and businesses and accounts for the flow of money. Notably, prior to the recession, the national income has been increasing. The consequences of the recession allowed the United Kingdom to demonstrate the growth of national income only in 2013 (Office for National Statistics, 2018).
Recovery
Graph 1 and evidence reviewed above suggest that the policy of the United Kindom’s government, as well as measures taken by banks, helped restore the economy. In the section dedicated to the monetary policy, the strategy of MPC and BOE were described, as the two authorities aimed to improve bank lending. For this purpose, the interest rates were lowered by BOE and reached 0.5% (Deleidi and Mazzucato, 2018).
The primary purpose was to attract investors and business owners and enable the flow of money. Therefore, by lowering its rates, BOE encouraged other financial institutions in a country to do the same. This should help increase the number of mortgages and the supply of housings, as well as help businesses expand (Horner and Stoddard, 2018). However, such an approach discourages people from depositing money since they would be able to earn less.
Conclusion
Overall, this paper focused on the fundamental concepts of macroeconomics, which help understand the specifics of recession and determine its long-term consequences. Macroeconomics refers to the examination of the economy of a country, in this case, the United Kingdom, as a whole. A recession can be defined as a noticeable decline in economic activity lasting for a specified period, which is usually reflected in the country’s GDP. The monetary policy of MPC and BOE helped the country recover and reach a GDP 11% greater when compared to pre-recession rates.
Reference List
Coulter, S. (2016) ‘The UK labour market and the ‘great recession’ in Myant, M., Theodoropoulou, S. and Piasna, A. (eds.) Unemployment, internal devaluation and labour market deregulation in Europe. Brussels: European Trade Union Institute, pp. 197-227.
Deleidi, M. and Mazzucato, M. (2018) The effectiveness and impact of post-2008 UK monetary policy. Web.
Heyes, J., Tomlinson, M. and Whitworth, A. (2017) ‘Underemployment and well-being in the UK before and after the Great Recession’, Work, Employment and Society, 31(1), pp. 71–89.
Horner, D. and Stoddard, S. (2018) Need to know: Edexcel a-level economics. London: Philip Allan.
The Great Recession, induced by the financial crisis, which lasted from 2007 to 2009, had a substantial influence on the sports industry and resulted in various negative consequences. It is possible to notice that the situation reduces the attendance of games, which had previously been a significant part of clubs’ income. Fans reassessed their spending patterns, which severely influenced the sports industry, especially lower-division teams (Buraimo et al., 2020).
The consequence is the growth in the unemployment rate, as clubs were not able to sustain the same level of expenses. The study conducted by Buraimo et al., 2020, shows that the Great Recession resulted in the regression of games attendance amounted to 7.9 percent that can be explained by growth in the unemployment rates in areas of clubs’ locating, which amounted to 9 percent (Buraimo et al., 2020). This evidence reveals the deteriorating of Sport Industry Economics caused by the Great Recession.
The influence of the Great Recession on distinct sports sectors is different. The private sector experienced financial losses, partially connected to the expenses, particular sports require from clubs. For instance, the golf clubs’ participation rate was decreased from 12% to 8.5% of the population, and in 2008, 106 golf courses were closed (Humphreys, 2010). Individual pursuits and gym memberships also decreased during the 2008 recession period (Humphreys, 2010).
In their turn, public and voluntary sectors were less vulnerable to the Great Recession. Sports league adult and children memberships rose during the period, as the costs of team sports are less than individual ones (Humphreys, 2010). Therefore, swimming can be considered a recession-proof sport, while the participation in local leagues only increased, and the public sports areas became more popular (Humphreys, 2010). It is possible to conclude that expensive sports in the private sector experienced significant losses, while public and voluntary sectors were not influenced or even showed the growth in the participation rate.
References
Buraimo, B., Migali, G., & Simmons, R. (2020). Impacts of the Great Recession on Sport: Evidence From English Football League Attendance Demand. University of Liverpool.
Humphreys, B. (2010). The Impact of the Global Financial Crisis on Sport in North America. In S. Butenko, J. G. Lafuente & P. Pardalos (Eds.), Optimal Strategies in Sports Economics and Management (pp. 39–57). Springer.
This news article is based on the claim made by the national treasury secretary on the need to prevent an unprecedented non-payment on U.S. debt. In an interview on CNBC, Janet Yellen stated that the U.S. is in a position of falling into another economic recession if Congress fails to address the country’s debt ceiling issue. She sustained that it would be disastrous if Congress could not take action by October 18, 2021, which she termed to be the deadline during the interview (Franck). Senate Majority Leader Chuck Schumer has been striving to get the Senate to pass debt-limit laws again. Nevertheless, Republican opposition has been pressuring Democrats to consider using a particular reconciliation system so the assessment can pass without GOP financial backing.
Yellen stated that President Joe Biden had not yet decided whether to re-appoint Federal Reserve Chief Jerome Powell to the office when his present term ends in February of the following year (Franck). Moreover, President Joe Biden called upon Congress to increase the debt ceiling this coming week and prevent an impending unequivocal economic recession. The article also features tweets by Senator Pat Toomey, who maintained that he believed that Democrats were apprehensive concerning being associated with debt limit amount around or above $30 trillion.
Event’s Greater Significance
The debt limit is essential in determining the economy’s stability since it establishes the maximum amount of money the country can borrow using issuing bonds cumulatively. The U.S. reached its debt limit on August 1, 2021, and there is an established debt limit of $28.4 trillion, which may lead to the shutdown of the government (The White House). When the federal government’s ongoing transactions cannot be financially supported solely by federal spending, it must borrow money to pay its expenses. Once this occurs, the Treasury of the United States generates and sells bonds; Such bonds represent the federal government’s debt. Hence, this event is necessary to outline the economic effects of passing the Federal debt limit. The federal government would be unable to meet all of its requirements due to the lack of funds. It is also helpful in demonstrating the role of Congress in maintaining the country’s economic state and preventing economic recession.
Be Woke
The economic consequences of such an unprecedented situation would almost certainly be negative. Nonetheless, there are still numerous uncertainties concerning the speed and amplitude of the harm the U.S. economy may suffer. If the administration becomes unable to pay all its expenses for an extended time based on how long the event lasts, how it would be controlled, or how much investors change their opinions on the security of U.S. Treasury bonds. An extended stalemate is likely to have severe economic harm in the United States. Even in the best-case scenario, where the impasse is resolved quickly, the economy is expected to experience entirely preventable, primarily due to the challenges that COVID-19 poses to the country’s economy. This news article’s events did not surprise me; therefore, I am still interested in the topic.
Stay Woke
Should citizens be worried if the debt ceiling is not lifted as suggested by the national treasury secretary, Janet Yellen?
What will be the consequence of the U.S. defaulting on its debt?
Works Cited
Franck, Thomas. U.S. Faces a Recession if Congress Doesn’t Address the Debt Limit Within 2 Weeks, Yellen Says. CNBC, 2021, Web.
The White House. The Debt Ceiling: An Explainer. U.S. Government, 2021, Web.
East Europe consists of countries that were formerly pursuing socialist economic ideologies. With changing economic variables such as increased competition in the international market especially for financial services, these countries have had to adopt capitalist economic policies. Before the 2008/2009 economic meltdown, the Eastern European region was leading in the boom for financial products such as credit facilities and securities.
However, the scenario changed after the meltdown which had adverse effects on the banking sector in the region (Uhde & Heimshoff, 2009). A lot of research has been done on the effects of the last recession on the banking sector in Eastern Europe with the aim of formulating the best strategies to save the region’s banking sector. However, little attention has been given to the opportunities presented by the recession to the banking sector in the region. Pursuing new strategies for addressing the effects of the recession might have long-term benefits. However, this might take longer and the effectiveness of the solutions is not guaranteed since they rely on the changes in economic variables (Uhde & Heimshoff, 2009).
Focusing on the opportunities attributed to the recession can help the banking sector to quickly recover. This justifies the need for academic research on the various opportunities presented by the recession. This paper will discuss the various opportunities in the Eastern European banking sector that are attributed to the recession. It will also compare and contrast the Eastern European banking sector and the US banking sector.
Review of Literature
Despite the adverse effects that the recession had on the Eastern European economy, the banking sector can still exploit the following opportunities and achieve higher growth. First, the banking sector in the Eastern European region is characterized by a credit sector that is yet to be saturated (Dinger & Hagen, 2009). This has two implications in the banking industry. The first implication is that the demand for credit facilities will continue to rise especially in the medium term and in the long-term as the economy recovers from recession (Dinger & Hagen, 2009). The second implication is that the competition in the market is not characterized by intense rivalry.
This means that the commercial banks in the region have the opportunity to increase their revenues by focusing on the credit market segment that is yet to be fully exploited (Dinger & Hagen, 2009). To realize this objective, the banks can consider reforming their business strategies and policies. This will include lowering the lending rates in response to the low purchasing power that is attributed to the effects of the recession. This will encourage borrowing in the short and medium-term. Consequently, the banks will increase their revenues and recover from the financial crisis.
The second opportunity is attributed to the macro-economic variables in the region that are likely to facilitate long-term growth in the Eastern European banking industry. Most central banks in the region have resorted to the use of unconventional policies to restore stability in the region’s banking sector. One of the most important unconventional policies used involved liquidity easing. Liquidity easing is a policy that aims at improving the supply of cash in the economy (Uhde & Heimshoff, 2009).
It was implemented in two ways in the region namely, domestic liquidity easing and foreign exchange easing. The economies in the region used systematic domestic liquidity arrangements in response to the blockage in the conventional systems of money transmission. This involved widening the counterparty access to the central bank liquidity facilities. It also involved relaxing the collateral requirements and extending the maturity dates for the liquidity facilities (Uhde & Heimshoff, 2009). Thus the banks in the region have the opportunity to obtain credit facilities from their respective central banks at lower interest rates. Besides, the extension of the maturity dates for the liquidity facilities will translate to higher returns in the long term. All these give banks in the region an opportunity to increase their revenue.
Foreign exchange liquidity easing involved foreign exchange liquidity injection and cross-central bank currency swop. Cross-central bank currency swop has led to the injection of foreign currency facilities in the region (Dinger & Hagen, 2009). The local banks can use such facilities to create credit facilities thus increasing their revenue. The use of this policy also led to the removal of capital inflow limits and ceilings on banks’ purchase of offshore foreign exchange. The central banks have also reduced the reserve ratio requirements for foreign currency (Dinger & Hagen, 2009). These changes have made the foreign exchange business in the region to be profitable. Besides, the banks have a greater opportunity to obtain credit facilities at reduced interest rates to expand their operations.
The third opportunity attributed to the effects of recession is the drastic reduction in the prices of IT products such as the use of the internet and banking software. In response to the reduced demand for IT products, the firms offering the products have lowered the prices to encourage purchases. The Western economies are particularly targeting the Eastern European region in order to consolidate their market share in the global IT industry.
Thus the banks have the opportunity to use new information technologies to improve their operations at reduced costs (Staikoura, Mamatzaleis, & Koutsomanoli-Filippoki, 2008). The banks can thus introduce new products such as the internet or online banking in order to increase their market share. The overall costs in banking will also reduce due to the reduction in the costs of IT products in the region. In the same way, the efficiency rates will be high in the region’s banking sector (Staikoura, Mamatzaleis, & Koutsomanoli-Filippoki, 2008).
The fourth opportunity is attributed to the effects of foreign banks in the region. The foreign banks especially from the Western economies have brought with their innovations in the banking industry. The innovation in this context relates to the product mix, pricing, and customer services (Staikoura, Mamatzaleis, & Koutsomanoli-Filippoki, 2008). Thus the local banks have the opportunity to learn from them and also improve their operations.
Thus in the long-term, the local banks will be more efficient and competitive (Staikoura, Mamatzaleis, & Koutsomanoli-Filippoki, 2008). The foreign banks in Eastern Europe were bailed out of the last economic crisis by their parent companies in the Western economies. The local banks have the opportunity to benefit indirectly from this strategy. This is because part of the withdrawals made from the foreign banks is deposited in the local banks. These deposits are used by the local banks to create more money. Consequently, they are able to improve their profitability in the medium term.
Finally, the banking sector in Eastern Europe is on its way to maturity (Dinger & Hagen, 2009). This means that the industry is still operating at under-capacity with more room for growth (Dinger & Hagen, 2009). The banks in the region can take advantage of this opportunity and increase their revenue in several ways. First, they can focus on increasing their branch network to reach out to more clients and increase sales. Second, they can introduce new products as well as differentiate the existing products. This will lead to greater revenue and market share for each bank.
Challenges in the Eastern European Banking Sector
There are four main challenges experienced in the region’s banking industry. First, the entry of foreign banks into the industry has had negative impacts, especially on local banks. The foreign banks have rapidly expanded their operations in the region due to their financial capabilities. Consequently, there is a lot of competition for the market share. This has led to reductions in the prices of various products in the industry and a lot of expenditure on product differentiation. Thus most local banks have become less profitable due to their inability to compete with their foreign counterparts (Staikouras, Mamatzaleis, & Koutsomanoli-Filippoki, 2005)
Second, the global financial crisis greatly reduced the competitiveness for new lending (Staikouras, Mamatzaleis, & Koutsomanoli-Filippoki, 2005). The crisis came at a time when the industry had lent a lot of money to the economy. However, the crisis slowed down economic activities in the region and this made it difficult for the borrowers to service their loans. This has led to a large number of defaulters. Consequently, the banks are reducing lending for fear of losing more cash. This has led to an increase in lending rates in the industry. The commercial banks are also obtaining credit facilities at high rates especially from their respective central banks. This further limits the competitiveness in lending and hence reduces revenue.
Third, the underperformance in the economies in the region has discouraged growth in the banking sector. The region is characterized by high inflation rates and instability in the financial markets (Staikouras, Mamatzaleis, & Koutsomanoli-Filippoki, 2005). This has discouraged investments in the sector as well as lowered the performance of the existing firms. High inflation and instability have particularly made it difficult for the economies in the region to join the eurozone. This means that such economies cannot take advantage of the large market in the eurozone and increase their revenues.
Finally, there is government interference with the operations of the banking industry in the region especially in countries like Russia (Steinherr, 1997). Through the fiscal and monetary policies, the local governments have continued to influence the operations of the industry. This involves influencing the lending rates as well as the level of cash flow in the economy. The central banks are not fully in control of the banking sector and this undermines the performance of the industry by limiting the scope of the central and commercial banks to make vital decisions in the industry (Steinherr, 1997).
Eastern European Banks versus US Banks
In comparing the Eastern European banks and the US banks, two similarities can be identified. First, banks in both regions are finding it difficult to recover the loans they lent to the public before the global financial crisis. This is because the borrowers are either bankrupt or are having low purchasing power. Consequently, the banks in both regions have had to rely on government support in order to remain in business. Secondly, banks in both regions are focusing on efficiency and product differentiation in order to maintain their competitiveness (Staikoura, Mamatzaleis, & Koutsomanoli-Filippoki, 2008). This is because traditional lending is still not attractive since the economies are yet to fully recover from the recession.
There are two main differences between the Eastern European banking industry and the US banking industry. Unlike the Eastern European banking industry, the US banking sector has already attained maturity. Thus the banks in the US are focusing on sustainability rather than growth since the industry is operating at near capacity. The Eastern European banks are focusing on growth since the industry in their economy is operating at less than full capacity (Dinger & Hagen, 2009). Second, the credit market in the US is saturated due to a large number of firms in the industry. Consequently, the cost of credit facilities is low as compared to Eastern Europe in which the market is not saturated.
Summary
The above analysis indicates that the banks in Eastern Europe were adversely affected by the global financial crisis. However, the financial crisis also presented growth opportunities for the banks. The main opportunity includes the use of an unconventional policy framework in response to the financial crisis. The policy has lowered the cost of obtaining credit facilities by the commercial banks as discussed above (Uhde & Heimshoff, 2009). Consequently, the banks have been able to increase their revenue. Other opportunities include a reduction in the cost of IT products and the innovations that have been introduced by foreign banks.
The main challenges to the region’s banking sector include the poor performance of the region’s economies, competition from foreign banks, and government interference with the operations of the industry. A comparison between Eastern European banks and US banks shows that banks in both regions are focusing on efficiency and product differentiation in order to maintain their competitiveness (Staikoura, Mamatzaleis, & Koutsomanoli-Filippoki, 2008). However, unlike the US banking sector, the Eastern European banking sector is yet to attain maturity.
Conclusions
The following conclusions can be made on the Eastern European banking sector. First, as banks focus on efficiency and product differentiation, expenditure on core activities such as payment processing and branch technology will significantly increase in the medium term (Staikoura, Mamatzaleis, & Koutsomanoli-Filippoki, 2008). This is because the banks believe that they can increase their profits by improving their efficiency.
Second, the banks are likely to partner with IT firms from Western Europe in order to obtain superior banking technologies. This is necessitated by the fact that high efficiency has to be facilitated by superior technology which is readily available in Western Europe. The banks are also likely to consider exporting their services to economies that have already recovered from the recession. This will help them to quickly recover from the recession and become profitable. Finally, each bank will have to reconsider its investment level to ensure that they do not underinvest. This is because they anticipate rapid growth in demand for financial products after economic recovery.
References
Dinger, V., & Hagen, J. (2009). How small are the banking sectors in Central and Eastern European countries. Journal of Finacial Regulations and Compliance, vol.17 (2) , 96-188.
Staikoura, C., Mamatzaleis, E., & Koutsomanoli-Filippoki, A. (2008). Cost efficiency of the banking industry in the South Eastern European region. Journal of International Markets, Institutions and Money, vol. 18 (5) , 483-497.
Staikouras, C., Mamatzaleis, E., & Koutsomanoli-Filippoki, A. (2005). Competition and concentration in the banking sector of the South Eastern European region. Emerging Markets Review, vol. 6 (2) , 192-209.
Steinherr, A. (1997). Banking reforms in Eastern European countries. Oxford Review of Economic Policy, vol. 13 (2) , 106-125.
Uhde, A., & Heimshoff, U. (2009). Consolidation in banking and financial stability in Europe: Emperical evidnece. Journal of Banking and Finance, vol. 33 (7) , 1299-1311.
Illustrations
This shows the performance of eastern European banks based on abstract views and file download views. The red line represents the abstract views while the blue line represents the file download views. The figure indicates unstable performance in the region’s banking sector.
Figure 2: inflation rates in Eastern Europe.
The high inflation rates discourage investments in the region’s banking sector. Inflation reduces the returns on investments especially in the financial markets. This has discouraged foreign firms from investing in the region’s banking and financial markets.
GDP (economic growth).
The figure indicates unstable economic growth in Eastern European countries. This has led to slow growth in the regions banking sector. An underperforming economy is characterized by low purchasing power. Consequently, a large percentage of citizens are not able to afford credit facilities. This lowers the revenue for banks and discourages growth of the region’s banking sector.
In economies around the world, a number of factors affect the operations of national income and expenditure that is gauged as the economic status of a country at a particular time. Economic barometers are the preserve of policy economists in the government with the understanding of both domestic and foreign fiscal policies at play in a country at that time. The status of a country’s economy is usually determined in collection of these measures, and done in quarters of fiscal years. These quarters may indicate economic growth or turndowns. The latter indicates a state in economic problems, either in domestic economy or in foreign economic terms and refers to an economic cycle.
Economic cycle (or business cycle) is the process of fluctuations in the activities of an economy and depicts its long term growth trends. The process involves periods of growth characterized by economic recovery and prosperity or stagnation characterized by retardation or recession. The general measure of the business cycle is the gross domestic product (GDP). When the GDP experiences a negative growth in two consecutive quarters, the economy is said to be undergoing recession.
This corresponds to the contraction phase of a business cycle. NBER (www.nber.org.) defines recession as “A significant decline in economic activity….. normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales”.
In this paper, an interactive analysis of the worst recession to have hit the United States economy in its recent history is presented. The causes of the 1990-1991 recession, its effects and analysis of the fiscal and monetary policies are presented using relevant economic models. The presenter further analyses how the recession was curtailed and the factors that led to the recovery of the economy. The writer concludes the study by summarizing the market perspective of the recession in reflection of all the three parameters mentioned above, i.e. causes, effects and recovery.
The recession that according to (www.nber.org, par.3) started in July 1990 and ended in March 1991, was also the worst in the world. Its effects were not only felt in the US. Other big world economies were also affected. The turndown started in North America and the UK which saw corporate profit rates peak in late 1988 while profits declined in among other countries, Germany and Japan save for those in the US and UK. This led to a fall in new investments and a decline in GDP and investment close to 7 percent and was the biggest since 1975 (Bernanke, 112).
Causes of Recession
The causes of recession are varied but there is a general feeling that the major factors contributing to recession are market speculations, economic inflation, national debt, currency crisis and to some extent, the existence of war. These factors contribute singly or in collection to affect the determinants of demand and supply in the commodity market and create changes in GDP growth, the national rate of employment and rise or a fall in prices of goods.
Speculation contains the feeling of assumed risk that creates loss for a possible rewarding venture or investment. It involves the processes of buying and holding of goods, selling or short selling of bonds, currencies, stocks or commodities, all forms of valuable instruments to gain in their fluctuating profits. This is done in contravention of normal channels of purchase to use such as through dividends or interests.
Crisis in currency or balance-of –payments crisis usually characterizes circumstances where there is a quick change in the value of a currency. This therefore reduces its worth to be used as a medium of exchange or as a way to store the value of a product.
Government debt refers to public money owed by any department of government and becomes an indirect debt to the taxpayer. These debts can be accumulated through deficit spending by the government at the expense of the amount of taxes levied. The categories of these debts can be internal such as money owed to investors within the country or external debt from foreign borrowing.
The factors mentioned above usually affect the aggregate demand and aggregate supply with direct effects on the country’s GDP, rate of employment and inflation. In the 1990-91 recession scenarios, the biggest contributions were the oil price increase in 1990 that saw an increase in inflation, massive deficit in government budget that slowed GDP and caused high cynical unemployment. This was further aggravated by a currency crisis occasioned by a decrease in aggregate demand (Robert, 275-279).
Aggregate demand is the demand for goods and services (Y) at a time and at a given level of price or simply the demand for GDP at stable inventory levels. It shows the various amounts of real domestic output that domestic and foreign buyers desire to purchase at each possible price level and an inverse relationship between price level and domestic output. An inverse relationship is not the same in the explanation for demand for a single product, which centers on substitution and income effects (Bade et al, 1810-1811). AD measures real GDP on the horizontal axis. AD curve sums all curves for different sectors of the economy. Thus,
Yd = C + I + G + (X- M)
Where C= Consumption = ac + bc*(Y – T), I = Investment, G = Government spending and X-M is the difference in total exports (X) and imports (M).
The model can also help determine the extent to which increases in aggregate demand lead to increases in real output or instead to increases in prices. An increase in any of the components of AD shifts the AD curve to the right. This increases both the level of real production (Y) and the average price level (P). If price rises, aggregate expenditures will fall because purchasing power of wealth falls, interest rates may rise, and net exports fall. If price rises further, real asset balance value falls, interest rates rise again and net exports fall. The equilibrium level of output determines the equilibrium level of employment in the model. Bringing in other considerations may imply this correspondence, though (Campbell, 27).
According to Broaddus (pg 13, par 6), when price levels fell, the purchasing power of existing financial balances rose. This increased spending. This state is referred to as the real balances effect. Also a decline in price level meant lower interest rates which increased levels of certain types of spending.
Similarly the foreign purchase was affected since other things being equal, U.S. prices fell relative to foreign prices, which increased spending on U.S. exports and decreased import spending in favor of U.S. products that compete with imports. Dollar depreciation discouraged importation into the country with serious effects on the exchange markets. The dollar could not be exchanged for as much money for different foreign currencies. These realignments affected the aggregate expenditure for given price levels during the time.
Fiscal Policy
When the government is involved in funding a deficit through the use of bonds, there occurs an increase in interest rates in the money market. This is as a result of government borrowing which creates a deficit, causing the aggregate demand to be high since disposable income starts to disappear in contravention to the objectives of deficit in budget. This concept is referred to as crowding out. In another related instance, through funding big projects such as construction or infrastructure development, government may increase its spending. This can also cause crowding out since opportunities are lost by private investors in undertaking the same project.
Another problem is the time taken between actual implementation of the policy and realizing what is affecting the economy. An approach to expansionary fiscal policy that is characterized by a decrease in taxes or an increase in government spending is normally enforced to increase in the aggregate demand for the fiscal period. However, if this spiraling in aggregate demand is not checked, it may easily lead to inflation. This therefore justifies the role of government in checking the effects of AD (Borio, 28).
When an economy experiences a slide into recession, it causes a decreased price level and a lowered GDP. This further affects the full employment which is calculated as a percentage of the GDP. The effect is an increasing negative GDP. If the government regulating agency decides to take an expansionary fiscal policy which shifts the aggregate demand curve to the right, the economy will respond by registering a full employment output free of the effects of inflation (Bootle, 113).
An increase in government spending also has the potential of creating an expansionary effect. This can also be registered with a decrease in taxes or a combination of the two effects. This can be used to eliminate the negative GDP gap created by recession. This approach can be used to restore full employment as a real measure of GDP.
While fiscal policy may be instrumental in increasing the aggregate demand, it does not act in total exclusion. Borrowing to finance deficit spending occasioned by the fiscal policy measures has a potential to increase interest rates that further crowds out investment spending. This can weaken the original idea of expansionary fiscal policy and even render it ineffective.
In the 1990-91 recession scenarios, the government increased its borrowing to fund domestic debts. This spiraled into a decreased aggregate demand that affected the economy. The government attempted to use specific discretionary policies to focus on long run issues of reforming tax and the state of social security. However, owing to the failures occasioned by these policies earlier, they were rejected by the congress on the basis that they were countercyclical and not able to stimulate growth from the recession.
Monetary Policy
The Fed’s job in creating stability of outputs in the shorts run and promoting stability in prices stability in the long run involves several steps. The Fed initially estimates how the economy is currently performing and how it’s likely to do in the near future. It then compares these estimates to its goals for the state of the economy and inflation. If a gap exists between the goals and the realized estimates, then Fed then has to decide how forcefully and how swiftly to act to close that gap. The lags in policy can complicate this process. But so do a host of other things. These include variables like employment, growth, productivity, and so on which reflect conditions in the past, not conditions today (Broaddus, 18).
Fed initially finds out what the most pertinent economic developments are such as taxing policies and policies on spending, important economic developments outside the country, foreign and domestic financial conditions, and the use of new technologies that promote productivity. The developments assumed in this process are then integrated into an economic model to observe how the economy is likely to develop over time. It’s hard to be sure about any approximation, in part because it’s hard to be sure that the model or meter the estimate is based on is the functional and right. There’s another important impediment in estimating the rate of highest sustainable growth; the fact that it can shift with time.
The experience of the 1990s provided a good example of the policy problems caused by such a shift. During this period, output and productivity surged at the same time that rapid innovation was transforming the information technology industry. In the early stages, there was no way for the Fed to tell why output was growing so fast.
The contributions of the Gulf war partly due to its costs and the uncertainty that accompanied it. The effects was to last a whole eight months of recession. This was followed by the oil prices spiking up from around $15 to over $35 per barrel which lasted up to early 1991. The result was an apparent postponement of household spending awaiting the outcome of the war. The economic activity contracted up to march 1991.
Monetary policy became less influential in averting the effects of the war because of the lag associated with policy implementations. At this time, the Fed was struggling from a credibility crisis that followed their handling of inflation. CPI inflation recorded a rise of up to 5.3 percent with a risk in inflation scare in the bond market if it responded by cutting the funds sharply. The reaction of the Fed was to bring the rates down to 6% at the close of the recession. The measures taken prior to the war and the happenings during the recession saw a recess in inflation with core CPI inflation decreasing to 4.4% by the end of the period.
The recovery was equally slow owing to the severity of the recession. Unemployment rose to about one percent during the period from the lower 5.5% at the start of the recession. The unemployment rate climbed marginally and peaked at 7.8 % by June 2002 in the wake of the GDP snapping back to 4% from 0.8 % between the periods March 1991 and June 1992. The monetary policy reaction saw the federal funds rate reduced from 6% in July 1991 to 4% by December 1991 and to 3% by October 1992. Inflation also fell with 3% by 1992.
The stance taken by the Fed was caused by the high rate of rising unemployment, the less capital in the banking system, expensive banking loans, the reduction in inflation and the gains against inflation that increased the credibility of the Fed so as to move to a minimal federal funds rate to stimulate AD and growth in jobs.
The move was very crucial because of the tendency of the policies to react differently relative to the exact reason of the economy’s faster growth. If it was assumed to react to new technology spread which improved worker and capital productivity, indicating that the trend growth rate was higher, then the economy could swell faster without causing inflationary pressures. In that case, monetary policy could stand touch. But if it was just the economy encountering a more ordinary business cycle growth, then price increases (inflation) could heat up. In that case, monetary policy would need to tighten up. The latter scenario was the case as the inflation heated up.
The Fed’s job became intricate because of the fact that statistical theories did not find sufficient evidence to suggest a change in the trend growth rate. But the Fed considered a range of indicators, which included the profit data from firms, as well as at unofficial evidences, such as anecdotes, to come to a conclusion that the majority of the verifications were consistent with an increase in the trend growth rate. On that foundation, the Fed did not tighten economic policies as much as it would have otherwise.
The turndown was characterized by fiscal effects reflected in interest rates and expectations of profit. High business taxes and a change in government spending that declined marginally. There was also a decreased net exporting that had no relation to price levels. The latter were as a result of low incomes abroad and low exchange rates for the dollar.
The Recovery and Expansion
By the end of the quarter, the Fed had to balance its policies over the uncharacterized inflation and recovered from the operational lags in implementing its fiscal policies. It undertook increasingly controlled expansionary monetary and fiscal policies. The policies on government’s taxing and spending as well as economic developments abroad had to be marginally reduced. Financial conditions at home and abroad had to be restructured to slow down spending through deficit spending techniques (Robert, 260).
The expansionary policies saw a downward trend of 4.7 % of the GDP on actual budget deficit and 2.9% of the GDP of full employment budget deficit in 1990 to lower to less than 3% of GDP in budget deficit in April 1993. This saw the expansion of aggregate demand and a rise in employment rates with minimal inflation. The government reduced its deficit in primary budget that resulted in reduced spending by the government. This also saw an increase in tax revenue although at low rates to supplement private growth. The duration of this fiscal adjustment was very short and the cuts in expenditure were substantial to see a largely positive proportional gain in taxes.
To finance the requirements of supply on capital formation, the Fed continually utilized controlled budgeting. This approach was to maintain public employment at the expense of consumption and capital transfers. The responses were, to a great extent, fiscal and avoided uneven ideology in dealing with uncontrolled expansion. The tax curve was flattened to correspond to the effects experienced on different tax brackets during the period. The full employment budget deficits were projected to show growth as the economy recovered from the recession.
The large actual and full employment rates threatened to result in high interest rates as it approached 1993. There was a threat of low investment and slowed economic growth. However, the Clinton administration increased personal income and corporate income tax rates to prevent these outcomes escalating into another recession. This counterbalance saw full employment budget deficit shrinking for the next couple of years with the country recording a surplus in 1999 (Robert, 264).
The real short rate was to be until 1994 February. This saw an increased employment rate of about 1.2 percent for the eighteen months following the monetary policy adjustments. The inflation rate also followed to fall slightly while the bond rate also fell to about 6 % in 1993. This was attributed to a weak expansion in the economy and a slow progression against the budget deficit during the time of recession. Another explanation of the fall in long bond rates was the acquisition of credible stance for low inflation that was attributed the Fed for the deflationary policy actions that had bogged them since 1988.
Conclusion
The challenges of recession in the US economy have been varied. These included rising inflation, restricted monetary policy, preemptive actions in the monetary policies, and the wars in Iraq and the war on terrorism among other policy imbalances and lag in reaction due to political ideologies. The Fed has grown more transparent in telling about the federal fund rates and shifting monetary policy to adapt to their credibility sustenance.
The 1990-91 was one of the periods that registered long cynical expansions in the economy of the United States. Much of the curious solutions that were adopted and promised did not work out. It turned out to be as difficult to manage just as the previous recessions prior to 1987 were. However, the fiscal and monetary reactions associated with transparent and focused regulatory framework enabled recovery from the recess.
Works Cited
Bade, Robin and Parkin, Michael. Foundations of Macroeconomics. 3rd Ed, 2007.
Miguel A. Kiguel, “Stagflation” Journal of Economic Literature, Vol. 23, No. 4. 1985, pp. 1810-1811.
Bernanke, Ben, and Mark Gertler. “Monetary Policy and Asset Price Volatility.” In New Challenges for Monetary Policy. Kansas: Federal Reserve Bank of Kansas City, 1999, 77–128.
Bootle, Roger. 1996. The Death of Inflation. London: Nicholas Brealey.
Borio, Claudio, and Philip Lowe.. “Fiscal, Asset and Monetary Stability: Exploring the Nexus.” Bank for International Settlements. 2001.
Broaddus, Alfred. “Transparency in the Practice of Monetary Policy.” Federal Reserve Bank of Richmond Economic Quarterly. 2001.
Campbell, McConnell, and Brue, Stanley. Economics: Principles, Problems, and Policies McGraw-Hill, 2004.
NBER. List of US Business Cycles. 2008. Web.
Robert, Hall. Macro Theory and the Recession of 1990-1991. The American Economic Review, Vol. 83, No. 2, 275-279. 1993.
“Cash is King” is a term utilized in many occasions to refer to cash flows in business entities. Moreover, the term has gained popularity in analysis of investment or business portfolios. Most investors use this term to refer to times of short-term debts as well as times of large cash flows. When investors talk of holding cash, then it is always assumed that they are not investing. In fact, holding cash is considered unpopular among investors. This is mainly because they feel that the money should always continue to rise. However, one thing that is never considered is the fact that during events such as recession, holding cash is advantageous. The assumption, that holding cash is a form of idleness is quite misguided, this is mainly because cash form an investor’s most prized asset. This rarely happen unless there is a cash crunch throughout a region, as was witnessed during economic recession. This paper will explore the evidence for this comment as well as analyze its viability (Fool, 2009, p. 1).
Cash is King
“Cash is king” is a term used to promote holding of cash in business entities, especially for use in times of recession. Several reasons have pegged the practice of holding cash among investors and business entities. Among these, include the fact that they cannot justify such actions. Lately, these notions have taken a new turn after the recently witnessed economic recession. Excessive leverage has fueled economic turmoil with lending that is below acceptable standards. When investors hold cash, they are usually protected from several snags. These include selling a cheap asset to buy another cheaper one.
In addition, it bars investors from benefiting from fascinating investments, for instance special occasions that may arise. A good example of a stock that suffered heavily from inadequate cash is the Bear Steams. This was a solid investment with all indications pointing towards its improvement. Then all of a sudden, it was in a mess. It was quite surprising to hear that a once solid business was down to its knees because of cash flow. Eventually Morgan Chase came to its rescue with a bailout. Interestingly, a once solid business was sold-off at over 90% loss. It is therefore important to note that cash opens gates for further investments. This can be proved as in the case of Pfizer, which grabbed Wyeth, in the process, opening door for Merck to pick up Schering-Plough (Fool, 2009, p. 1).
Discussion
“Cash is King” is therefore a true expression in itself. Companies that have solid cash flows can afford buyouts at any moment. In fact, these companies have the ability to cope during crunch times in stock market. For instance, when fear grip the market, only companies with cash flows can survive. One assumption that misleads people is the thought that solid liquidity and stock value can help companies to secure large sums of monies for acquisitions. It is quite important to note that this applies only during merry times when the market is either stable or expanding. However, if the opposite is happening, valuation of stocks is greatly affected, and this has the ability to cause a close down of the company. In essence, Cash is King and companies should ensure there is continued cash flow, to ready them for any eventualities (Tilson, 2000, p. 1).
Conclusion
“Cash is king” is a term used to refer to and promote holding of cash in business entities, especially for use in times of recession. Several reasons have blocked the practice of holding cash among investors and business entities. It is quite important to note that this applies only during cheerful times, when the market is either stable or expanding. However, if the opposite occurs, valuation of stocks is greatly affected, and this has the ability to cause a close down on the company. In essence, Cash is King and companies should ensure there is continued cash flow, to ready them for any eventualities (McInerney, 2005, p. 1).
Systematic influences on portfolio refers to external risks inherent in a market segment or in the entire market. If an investor has put too much reliance on cybersecurity stocks, for instance, they can diversify by buying stocks in other industries including healthcare and infrastructure. Interest rate changes, unemployment, recessions, and wars, among many other major changes, are all part of systematic risk. Changes in these categories have the capacity to alter the broader market and cannot be compensated for by changing positions in a public equities portfolio.
The group mentality of investors, or their desire to follow the market’s direction, is what causes market risk. As a result, market risk refers to the tendency for security prices to move in lockstep. Even the share prices of well-performing companies fall when the market falls. Nearly two-thirds of total systematic risk is market risk. As a result, systematic risk is also known as market risk. The most common thing to avoid in securities is market price fluctuations. A prime illustration of systematic risk is the Great Recession. Everyone who was invested in the market in 2008 saw the value of their investments fluctuate as a result of this market-wide economic disaster, regardless of what types of assets they possessed (Rognlie et al., 2018). However, because the Great Recession hit different asset classes in different ways, investors with broader investment strategies were less harmed than those who only held stocks.
For several reasons, investors should become aware with systematic risk and its outcomes. First, because systematic risk is inevitable, the probability is high that an investor will suffer a loss as a result of it at some point. After all, wars, natural disasters, and weather events do occur. Second, portfolio diversity cannot protect against systematic risk. In this instance, diversifying your investment portfolio over a range of payment instruments and market sectors will not reduce the risk of investing.
To avoid systematic risk, investors should diversify their portfolios by including profits, capital, and property investment, as each will respond better in the case of a severe systemic change. If investors feel executive teams are scaling back on expenditure, an increase in interest rates will boost the value of some bonds issued while reducing the value of some business equities. If interest rates rise, having a portfolio with plenty of income-generating securities will help to offset the loss of value in some shares.
While considering the EMH, stocks always trade at their fair value on exchanges, making it difficult for investors to purchase cheap equities or sell at inflated prices. As a result, skilled taking orders or market timing should be impossible to exceed the entire market, and the only method an investor can earn higher returns is to buy riskier stocks. The widespread acceptance of the efficient markets theory has boosted the popularity of alternative investments that track significant market indices, including mutual funds and exchange-traded funds (ETFs). Investors that adhere to the EMH are more likely to invest in passive index funds. These funds aim to replicate the market’s overall performance, and less likely be paid high fees for expert fund management since they do not expect even the greatest fund managers to surpass average market returns.
Indeed, during the exercise, it was seen the work of effective market hypothesis. For example, share prices included all the information that we needed to make investment decisions. The relevance of the EMH has been disputed on both conceptual and empirical levels during the investigation. There are investors who have outperformed the market, made billions by investing in inexpensive stocks and set an example for many others. Others have a better track record and are more well-known for their data analytics than asset managers and investment businesses. Individuals who generate larger returns, on the other hand, are subject to chance constraints, according to advocates of the EMH: in a system with a wide range of players, some will surpass the standard at any particular time, while some will underperform.
Active portfolio managers think that by combining their particular ability and expertise with that of a team of skilled stock analysts, they may exploit market failures and outperform the benchmark. Both sides of the debate have evidence to back them up. The Morningstar Active vs. Passive Barometer is a two times report that compares active and passive managers’ performance. The 2020 study looked at over 3,500 funds and found which only 49% of actively managed mutual funds beat their passive rivals for the year (Rognlie et al., 2018). Active investors’ techniques are called into doubt by their strong conviction in the efficient market concept. If markets are perfectly effective, investment firms are wasting money by lavishing bonuses on top fund managers. The rapid expansion of portfolio in index and ETF funds implies that many investors believe in some version of the thesis. Day traders, on the other hand, rely heavily on technical analysis. Fundamental analysis is used by value managers to find undervalued stocks, because there are hundreds of found in a great in the United States alone (Rognlie et al., 2018).
Due to buyers and sellers often have access to the information, the efficient market theory indicates that there is a strong correlation connecting information (or data) and pricing. Prices move smoothly (in a timely basis) when they are based on public knowledge, which means equities are trading at their ‘fair’ price. Because proponents of the idea claim that the market is random, knowledge cannot be expected by the general public. As a result, investors will be unable to “beat” the market by purchasing inexpensive stocks or selling at inflated prices. The efficient market theory indicates that you cannot regularly surpass the market average in terms of investment returns, even if you get lucky once in a while. Consequently, investors are forced to make judgments based on guesswork, which carries significant risks.
As the proponents of the idea claim that the market is random, knowledge cannot be expected by the general public. Due to that, investors will be unable to “beat” the market by purchasing inexpensive stocks or selling at inflated prices. The theory of efficient market indicates that you cannot regularly surpass the market average in terms of investment returns, even if you get lucky once in a while. As an outcome of this, investors are forced to make judgments based on guesswork, which carries significant risks. The efficient market hypothesis, on the other hand, has immediate implications for investors and analysts. The concept allows little room for technical or fundamental analysis by implying that stock return estimates are based solely on guesswork.
Reference
Rognlie, M., Shleifer, A., & Simsek, A. (2018). Investment hangover and the great recession. American Economic Journal: Macroeconomics, 10(2), 113-53.
The focal point of the paper is to analyze and examine the nature how the fiscal policy or expansionary fiscal policy could help a country in recession and the possible problems associated with it. To understand this paradox it would be relevant to use the current crisis bailout plan to confront recession as a model. The trend of the international investment position of the U.S. could be termed as a problematic situation because with the balance of payment being negative there lays a subtle chance of market crash and even probability of deflation. The example of East Asia could be enumerated in this situation where it was found that the credit volumes of the economy of those countries lead to the massive market crash. Since the crisis emerged last year, most of the banks have had losses related to the investments in the poor USA housing markets. This has happened mainly due to the sub-prime borrowers who have very poor credit history and the default records of the USA home loans have caused the worth of the assets to sink, making the banks hesitant in lending money to each other. (Grynbaum, 2008)
Main body
The US Federal Reserve has put in major efforts to resolve the present problems involving credit and liquidity in the financial world as a rescue policy to counter recession. They are helping the financial banks to revive from the rock bottom, which they have hit in recent times, by engaging $180 billion. (3news, 2008) Nevertheless, the recession crisis continues even after several months since it first began last year. The mortgage lenders have announced a reduction in the total number of home loans that they are approving, mainly due to the problems that the banks are facing in producing funds on marketable money markets. This huge crisis in the credit market has not only hampered the world’s economy and its growth, but people also expect USA, which is the world’s largest economy to enter into a depression (Grynbaum, 2008).
There is a fiscal policy plan that includes an additional input of US$800 billion by the Federal Reserve. The amount of US$800 billion would be instrumental in buying the debts related to mortgage and the credits of the consumers in order to instrument a lending free up. At this point of time, it appears that there are two major problems related to this fiscal policy plan. The first one is the fact that there is not enough retail economy spending in relation to consumers. Secondly, there is a lack of consumer credit and there is no presence of a sound economy to sustain this amount. It is reported, “the Federal Reserve and US Treasury are pumping a jaw-dropping $800 billion directly into the credit markets, buying up $600 billion worth of mortgage debts” (3news, 2008). The net probable result however, there is the danger of creating a credit gap and this could result in further recession.
Conclusion
Whether the fiscal policy or the expansionary fiscal policy will be able to reinstall the confidence of the uneasy credit market in the long run, is still an unanswered question. According to a BBC editor, the actions of these various banks may help to solve all the liquidity problems, like facing temporary shortage of funds, but it may not be able to ease their worries of resolving their long-term financial problems. There has also been a second phase in the crisis where most of the banks are uncertain when it comes to lending money to each other, either out of liquidity shortages or out of a general concern that the borrower bank will not be able to pay back the amount in time. This has created the well-known crisis of confidence (Grynbaum, 2008).
Bibliography
3news; US to try bailout ‘plan C’ to solve credit crisis; 3 News / CBS; Wed, 2008;
Grynbaum, Michael M. Persistent Anxiety Over Tight Credit Sends Stocks Plunging. NYTimes.com. 2008.
