Friday, February 6, 2009

Will Obama's Fiscal Stimulus Plan Work On Time To Prevent Onslaught Of Unemployment?

I’m sort of uneasy with these 2 quotes recently. Both were from BBC, 6th Feb:

“The US unemployment rate rose to 7.6% in January, up from 7.2% in December, the highest level since 1992”

“In total, the US economy has lost 3.7 million jobs since the recession began in December 2007, with nearly half of those jobs shed coming in the past 3 months”

Economic interpretation:

The first quote shows that unemployment has been rising at an increasing rate due to the reasons which I will discuss later. Highest since 1992 means we have never seen such rate since that period

I’m more interested with the second quote. The moment I read, I tried to perform some rough & simple arithmetic on it. Half of the jobs lost were reported in the recent 3 months? Wow! That means we have 1.8 million Americans being jobless just within November to January, with an average of 600, 000 ‘casualty’ per month. Meanwhile another 1.8 million job losses since December 2007, brought about 150, 000 ‘casualty’ on average per month. How did this happen? The answer is of course through negative multiplier effect. By the way, if we are going to plot all this on a graph, I believe it will look somewhat exponential. This further support my first statement, saying that the unemployment rate will be increasing at an increasing rate

Why unemployment will be higher over time?

(1) Politicians fault.
I’m not talking only about US, but generally politicians all over the world including my home country, Malaysia. I’m somehow amazed & at the same time feeling amuse as how politicians care more for themselves than the public at large. They seem to politicise every single thing tabled, hoping to gain popularity even in the period of recession

For instance, while I understand that ballooning fiscal deficit in US is unhealthy due to continuous spending by Federal Government, somehow it is necessary to jump start the economy. Think about this. How many options are left? Slashing interest rates did not work. Cut in rates were not passed on. People continue to be thrifty & this caused US economy to contract further. Quantitative easing by far has not proven any visible results. Lending activities continue to weaken as banks are seizing the opportunity to refurnish their balance sheet, causing property market to be in worse state. Tax cut I believe will be save for paying debt. The only tool left is to reverse the onslaught-that is creating employment for those unemployed. At least it will revive some confidence into the economy

However not to forget 2 thing the implementation lags & effect lags. Legal procedures even in the present state may take weeks if not months to execute. Secondly, even after implementation we may not be able to see those 4 million jobs created with immediate effect as publicised by Obama. Presently, the unemployment toll in US is 3.7 million. I was thinking, even before Obama has created 4 million jobs, by next month the unemployment would surefire exceed that amount!

(2) Negative multiplier effect. In general, it means an initial fall in AD will cause a substantial larger fall in AD later. I will talk about consumption, since US economy just like UK economy is consumption-driven. Here, more than 70% of US economy is made up of C. Hence ballooning unemployment will trigger a spending crisis. As people are out of job, they will automatically cut their spending into the economy. Firms on high street begin to shed jobs since there is no point hiring so many workers, when the demand for their output is so low. This leads us to second round of unemployment. Now, with even more people out of job, contraction in consumer spending will be magnified Companies make even larger losses this round (depends also on nature of business & number of workers they have) & in return retrench more of their workers

This cycle will repeat itself. But don’t forget, there could be many other sectors of the economy that rely on it. For e.g. if the Big 3 really go under administration, various spare part suppliers will suffer. Suppliers of raw materials e.g. steel, rubbers etc are not spared too. Banks will then lose of their biggest & yet most loyal customers that contribute to their profit every year. The list goes on. These explain why unemployment may increase according to geometric progression

(3) Paradox of thrift. In recession, the best thing one can do is save more money for rainy days. However, in the end this could bring more harm than benefit to the economy & that person itself. The reason is simple. If everyone begins to save, there will be no active spending into the economy. Leakage is said to have taken place. Private spending being the most important component of American economy will slow down & then shrink into negative territory. Economy will also move at slower pace before moving into recession. By then companies will make losses & the era of retrenchment will take place. It will be enlarge by the multiplier effect as explained above

In short, I seriously don’t think Obama’s plan will work on time to slowdown the rising unemployment rate based on the economic principle discussed. Somehow, I argue that the key to economic revival lies in the hand of financial institutions. As long as they are not willing to start lending, we will remain (or worse) in current state as where we are. If only we can make them lend

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