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by Valentino Piana (2015)



1. Summary features of this phase in the business cycle
2. Typical pathways in key economic areas
3. Key events
4. Winners and losers
5. Influence on election outcomes
  6. Risks of countervailing developments  
  7. Transition to the next phase  

8. Empirical examples


Summary features of this phase in the business cycle

Strong, well-oriented and effectively executed counter-cyclical policy packages reverse GDP recession or depression. International developments may significantly contribute to turn-around, while domestic autonomous forces would require painfully long mechanics to reach the same effect. The solutions of long-standing structural problems of the country are neigher a necessary nor a sufficient condition for U-turn, but their absence means that an opportunity of transformation has been missed, leading to shorter, more erratic, and less resilient growth in what follows.

Typical pathways in key economic areas

Domestic policies

Fiscal, monetary, industrial, labour market and trade policies are selectively or broadly used to contrast and invert negative recession or depression. Fiscal expansion, with higher purchases of goods and services by the public administration, is effective in increasing aggregated demand, provided it is large enough. Although in principle what matters is the sheer size of the stimulus, it's composition is relevant as well, with more effects linked to purchases of larger quantities (not dissipated by higher purchasing prices) of goods that do not crowd out private consumption but instead add or even complement it.

Tax cuts to wide segments of the population sustain disposable income and, depending whether they are saved or consumed they might add to aggregate demand.

Increased aggregate demand translates into GDP, net of leakages towards imports.

A drastic cut in taxes on profits generated and received (corporate profits, sole owners' and rich households incomes) may boost profitability and propel an investment-led recovery and expansion, especially if complementary measures are taken to assure demand for the products obtained by such investments.

Expansionary monetary policy, resulting in lower interest rates on households, corporate and public debt (and investments) as well as larger money quantity, hinges on a variety of technical instruments employed by the central bank. If, when and to the extent such expansion is transmetted through banks and financial intermediaries to the real economy, it improves the balance sheets of borrowers, keep some of them afloat, reducing their risk of bankrupty, reduces liquidity constraints, and provide the green light to initiatives and projects judged as profitable. In a negative environment, such projects are few and risky, so it takes time to stimulate private investment.

In absence of fiscal stimulus, monetary policy is ineffective. Lack of promising and relatively safe investments domestically might lead to outwards financial flows, with positive impacts mainly on foreign economies.

In economies relying of few goods and sectors for their GDP fluctuations, industrial policies addressing sectoral bottlenecks, if implemented quickly enough, might leverage out from company and sector level to the macro-aggregates, by working on the marginal change of GDP.

Policies on labour supply, skills, remuneration, and contractual features allowed or favoured (e.g. fiscally) by the law can change the distributional impact of the crisis, the balance of power between employees and employers, so offering a new setting for company-level decision-making.

An exchange rate depreciation, possibly connected with domestic interest rates lower than abroad, is a broad-range trade policy capable of inverting the negative trends. In countries where exports are both large with respect to GDP and are concentrated in few countries and products, specific export promotion measures or bilateral agreements can decisively contribute to the U-turn.

Autonomous foreign trade dynamics

If other countries are expanding, their imports from one in recession or depression might elevate it out of the crisis, if they are large enough. This is especially true since imports fall more than GDP, so for a moment, their fall adds to "net exports" (usually not a large but quickly moving component of GDP).

In this case the country-level U-turn is due to a favourable U-turn somewhere else, which in turn must be generated by their domestic policies, in the logics of the international business cycle.

Autonomous business dynamics

What if policymakers decide not to change any of the policies and conditions which dominated and produced the recession and they are not lucky enough to have large trade partners solving the problem?

Is the private sector capable of autonomous U-turn in business cycle? A large fall in prices, if not reflected in nominal wages, would increase real income, especially of wealth-owners and fixed incomes (e.g. pensioners). If their cumulative bundle is getting older and weared-and-teared, they would decide to increase their consumption. If the additonal purchases are large enough to overcome the tendency of consumption to follow GDP, then the larger utilization of existing capital and workforce (including through sales of inventories cumulated during the downturn) would increase profitability and, later on, investment.

However, this mechanism takes long time and is uncertain: if the new purchases are smoothed in a long period, e.g. in expectation of further price decline, then aggregated consumption would not rebound. If indeed rebound takes place, but selling inventories is enough to satiate it, the windfall profit does not lead to new investment, the more so if the productive capacity is well below full utilization.

Positive surprises in specific sectors (e.g. the discovery of a new oil field or the world demand for a specific country product due e.g. to an innovation) might occasionally - and in small open countries - provide the leverage for the turn-around. Until such uncorrelated lucky events do not take place (or the context is too large or depressed to let them make the difference), stagnation continues.

Labour market

At trough, employment stop falling. Earlier, the pace of degradation was reduced, later employment starts increasing. To stop firing, an explicit policy might be temporarily introduced or may be sufficient for the policymaker to generate the expectation that things will improve.

Public finance

Depending on the type of adopted policy (or the lack of it), during the few months of the U-turn the public deficit soars under expansionary fiscal policy or slightly improves under expansionary monetary policy (because of reduction in expenditure for serving the public debt). Industrial, labour-related and trade policies are usually not particularly expensive on a macro scale, so the public defict remains more or less at the same level.

Things change when the turnaround is passed and a phase of recovery begins.

Financial markets

Credible announcements of broad anti-cyclical policies and specific measures on financial stability may reverse stock exchange plumbeting, especially because of internal logics of rebound.

Key events

New leaders guiding the country, especially if raising from the ranks of opposition or milieux not connected with the reasons for the crisis are usually important for the turn-around.

In countries where specific industries play crucial role, changes in corporate leadership or new FDI providing room for optimism might help.

In another setting, if the recession was provoked to stop inflation, a reversal of interest rate hikes and a fiscal expansion can be put in place by the same government.

Winners and losers

A hefty debate about how to exit the crisis usually takes place, the more so if a government make bold moves: the opposition will usually strongly criticise them, deeming them dangerous. But if turnaround effectively occurs the interests protected by the government enjoying such moves will thrive, whereas the interests defended by the opposition usually will continue to suffer until expansion, and not just recovery, is in place.

Influence on election outcomes

If turnaround has just happened, its fruits may not be easily perceived by the common household, so the government might not be enjoying positive support at elections held in that moment, if dominated by economic arguments.

Possible countervailing developments

Before the U-turn, everything is going badly (high correlation across variables). With the strong policy or foreign push, a few variables are reacting, but most of the others continue to degrade.

Quartal data of GDP can give contrasting signals, with early hopes being frozen by bad data and afterwards corrected up again.

The same policy package might involve degradation of related variables (e.g. an expansionary fiscal policy will worsen the public deficit). If overreaction to such physiology takes place (e.g. before such policy brings fruit, it is reverted by the attempt to tame the deficit) the turn-around is suffocated and aborts.

An export-led push, if too early matched by increase of imports, may not be sufficient to invert the cycle.

Transition to the next phase

A successful macroeconomic turn-around leads to a recovery and (more or less quickly depending on the strength and execution of the policy package) to expansion. If turn-around is too tactical and do not lead to a sustainable dynamics (or the policy package is abandoned too early), a double dip recession may take place.

Empirical examples

* USA 2009: after falling until mid-2009, the economy has bottomed up, due to a very large fiscal expansion (approved in February) and an expansionary monetary policy in place since 2007 (first interest rate cut to 4.75% from 5.25%, resulting from an increase in June 2006). The central bank cut rates six more times until rates were at 2% in April 2008, paused until the Lehman Brothers crisis and then cut rates twice in October 2008 and once again in December 2008 when rates reached 0.25%. The election of the suprising candidate Barack Hussein Obama has led to a drastic change in policy approaches and been harshely criticised by opposition, predicting the failure of his economic recipes. In March 2009, the stock exchange stop falling and begin to rise.

Employment slows down its fall from March, with May marking a significantly better result, further months exhibiting improving tendency (notwithstanding the absolute fall) and first employment increase in March 2010.

* Italy 1984: After a fall by 1.2% the year earlier, GDP has risen by 2.8%. The external push has come from USA (to which Italian exports have risen by a amazing +70%), leading to an overall rise of exports by 6%. However, this would not be enough without a fiscal spending that lead public deficit to 15% of GDP, because imports have risen by 7.2%, thus net exports have been negative (and growingly so). Private investment have been rising by 2.2%. No effects on employment yet and even a growth of unemployment rate (10.5% instead of 9.9%). Inflation is falling from 14.7% in 1983 to 10.8%.

GDP time series for most country of the world (1946-2007)

* USA 1992: after having dismissed the existence of recession, and having announced several times that recovery was underway, President George Bush admits that the economy is not going well (in 1991 GDP falls by 0.1%).

Contrasting quarterly data in 1992 show a promising first quarter, a deceiving second one and an acceleration in the third and fourth, partially detected with delay and data revisions, leading to an ex-post evaluation of 3.6% growth.

While the incumbent emphasises foreign policy success and moral values, the challenger wins the presidential election talking about the economy and his plans for improving it. In 1993, GDP grows by 2.7%, with USA resulting the fastest moving economy of the G7 and beginning a long period of prosperity.


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