How to exit a recession?

The starting point to exit a recession is boosting consumption through the implementation of most pass-through tools.

As businesses are free to do whatever with cheap funds, they participate in the stock price bubble. To invest in real goods, businesses need to see an upward trend in their revenues which will not happen until the demand for consumption goods revives.

A radical monetary tool to boost expenditure would be monetization of spending in which a central bank would type money and transfer to consumers.

Fiscal policy predominates monetary policy as it does directly finance goods and services. Central banks also require direct tools to promptly stimulate spending.

Investment depends on consumption

Almost all economists agree that expansionary monetary and fiscal policies are required to exit a recession. In practice, it is not so easy. The sequence of tools' implementation makes profound difference.

A recession is the state of economy in which demand is insufficient. To boost demand, authorities promote sales of goods and services. Compared to consumption goods, investment goods are less affected by policies as investments are mainly driven by sales projections. Therefore, aiming at a higher investment rate is not a good start to exit a recession. The first step should come from consumption.

Unfortunately, major central banks' strategy against the COVID-19 is upside down. Through quantitative easing, they expect businesses to boost spending. However, businesses don't raise consumption just because of access to cheap funds, unless their costs exceed revenues. On top of that, quantitative easing doesn't require them to buy real goods. To invest in real goods, they need to see an upward trend in their revenues which will not happen until the demand for consumption goods revives. As they are free to do whatever with cheap funds, they participate in the stock price bubble

The response of the US authorities to the 2008 financial crisis has been a guiding lesson in which the tools were applied in the right sequence. First, a strong fiscal stimulus was provided by the Treasury whereas the Fed contributed to a higher spending depressing deposit rates. When President Obama lost majority in Congress, fiscal policy had already pulled the economy out of crisis. To sustain the recovery process, the Fed bought treasuries and mortgage papers in massive amounts. Funds provided by the Fed flowed in both consumption and investment goods as expectations had morphed into positive by that time.

In the middle of a recession in 2020, the transmission mechanisms are totally broken while economic actors anticipate a lower income in the near future. Due to deteriorating delinquencies, banks don't expand consumer credits. Authorities should thereby boost consumption as direct as possible. Fiscal subsidies are one of the most effective tools for this purpose. In the uncertainty of COVID-19, governments should not try to determine a sufficient amount of fiscal package, but they should rather boost spending as much as they can. Once the economy recovers, they can easily withdraw excess stimulus through raising taxes.

Monetary policy has already exploited the interest rate room which is narrower than the one in 2008. New tools would be required as quantitative easing is impotent to foster consumer spending. Via a leverage tool, a central bank can enforce banks to expand consumer credits. In this context, banks would be required to convert a higher ratio of their deposits into credits. Thus, consumption would be bolstered.

A radical monetary tool to boost expenditure would be monetization of spending in which a central bank would type money and transfer to consumers to spend. Such a tool would generate instant improvement in spending as it necessitates no transmission mechanism. Once the inflation target is achieved, the central bank would stop its spending program and raise interest rates to control inflation.

The starting point to exit a recession is boosting consumption through the implementation of most pass-through tools. With the current toolset, fiscal policy predominates monetary policy as it is able to subsidize consumers without depending on an intermediary. Central banks should also seek direct tools that promptly stimulate consumption.