FIN-FPX 5710 Economic Foundations for Financial Decision Making

Introduction

This report examines potential indicators of an economic recession, explores the fiscal and monetary policy measures that governments can implement to address a recession, and evaluates the different approaches that Keynesian and Austrian economics take when responding to such an economic downturn. Additionally, actionable recommendations will be provided to the firm based on these insights.

Recession Indicators

A recession is defined as a period of economic decline, typically lasting at least six months, characterized by reductions in output, income, and employment. Business activity contracts across various sectors, leading to declines in GDP and rising unemployment rates (McConnell et al., 2021, p. 259). According to Sarah Foster, consumers should focus on several key recession indicators, including bond interest rates, consumer confidence indexes, unemployment data, the recession probability model, and the GDP input/output gap (Bankrate.com, 2019).

Bond interest rates are important because when their trend begins to decline, it indicates a greater risk associated with short-term investments. Inversions in the yield curve have historically preceded each recession over the past 50 years (Foster, 2019). Consumer confidence indexes measure how optimistic consumers and businesses are about the economy. For instance, trade tensions can impact investment decisions due to uncertainties about the future (Foster, 2019). Additionally, unemployment data provided by the Department of Labor, which includes both the unemployment rate and job creation data, can signal issues in the labor market if there is a consistent rise in jobless claims (Foster, 2019).

Another critical recession indicator is the recession probability model published by the Federal Reserve Bank of New York. This model is based on Treasury yields and indicates the likelihood of an economic downturn within the next year, with concern growing when the probability exceeds 30% (Foster, 2019). Finally, fluctuations in GDP, particularly when there is a negative gap between actual and potential output, can strongly suggest a recession (Foster, 2019).

Fiscal and Monetary Policy Changes for Addressing a Recession

When addressing a recession, governments can implement fiscal and monetary policies to stimulate economic recovery. Fiscal policy involves altering government spending and tax collections to achieve full employment, control inflation, and encourage economic growth (McConnell et al., 2021, p. 647). Expansionary fiscal policy, such as increased government spending or tax cuts, can raise aggregate demand, thus boosting real GDP (McConnell et al., 2021, p. 648). Historical examples of successful fiscal policies include tax cuts by the Bush administration in 2001 and the Obama administration’s stimulus packages during the Great Recession (McConnell et al., 2021, p. 655).

Monetary policy, controlled by the Federal Reserve (Fed), focuses on managing the money supply to influence interest rates, aiming to stabilize prices, achieve full employment, and promote economic growth (McConnell et al., 2021, p. 704). During a recession, the Fed may take actions like lowering interest rates or buying government securities to increase the money supply and encourage borrowing and investment. The Fed’s measures during the Great Recession, including reducing interest rates and purchasing securities, played a crucial role in economic recovery (McConnell et al., 2021, p. 725).

However, both fiscal and monetary policies have drawbacks. Fiscal policy faces delays in data collection, recognition of economic issues, legislative approval, and implementation, leading to a slower response to recessions (Mishkin, 2019, p. 567). Meanwhile, monetary policy can be less effective in addressing severe recessions due to cyclical asymmetry and the possibility of a liquidity trap, where adding reserves does not stimulate lending or demand (McConnell et al., 2021, p. 726).

Keynesian vs. Austrian Macroeconomics

Keynesian and Austrian economists have contrasting views on how to respond to economic recessions. Austrian economists advocate for minimal government intervention, viewing recessions as natural economic cycles that lead to new business opportunities (Ramraika, 2015). They argue that free markets will self-correct without significant government involvement, assuming that individuals will make rational economic decisions based on their understanding of how the economy should function.

In contrast, Keynesian economists believe in active government intervention to stabilize the economy, particularly through fiscal and monetary policies (Blinder, n.d.). They emphasize the importance of government spending and tax cuts to influence aggregate demand, with a focus on addressin