Aggregate demand and economic recovery during recessions

Expansionary Mode

According to the Organization for Economic Corporation and Development (OECD), if the Composite Leading Indicators of a country is increasing and has attained the value of 100 or above, the economy of that country is said to be in an expansionary mode. On the other hand, if CLI of a country is declining and the value has increased above 100, this implies that country is on a downturn (The Hindu, 2010).

Needless to say, if an economy is to enter the expansionary mode, there are certain policies that the economists have to adopt. Expansionary policy is a macroeconomic policy that is used to increase the money supply so that inflation is combatted or economic growth is encouraged. Fiscal policy is a kind of expansionary policy that seeks cuts in taxes, and encourages rebates and increase in government spending. Central banks can also devise expansionary policies that focus on expanding the money supply of the economy (Hyo-sik, 2009).

Although there are many risks involved, the expansionary policy is a tool that is useful to manage periods of low growth in the business cycle. The most important thing for the economists to know is the appropriate time for the expansion of money supply so that high inflation can be avoided. It should also be remembered that there is always a time lag between the implementation of a fiscal policy and its effects.

Recession

Recession is defined as a substantial decrease in the activity of the economy that lasts more than a few months. It becomes evident in employment, production, wholesale-retail trade and real income. The economic indicator of a recession in the economy is two quarters of negative economic growth, back to back, that is determined by the gross domestic product of a country (Samuelson and Nordhas, 2005). However, it is not important for the National Bureau of Economic Research to term the economic conditions of a country as recession.

Recession forms a normal, yet unpleasant, part of the business cycle. Nonetheless, crisis events at a particular time can stimulate the start of recession. The universal recession of 2008-2009 brought forward a huge amount of attention for the investment strategies that are risky and implemented by many financial institutions. It should be remembered that generally, recession lasts for about 6 to 18 months. During the time of recession, interest rates decline during this time period to trigger the economy because of cheap rates at which people and investors can borrow money.

Depression

Depression is a recession that is severe and sustained. As mentioned earlier, recession forms a normal part of the business cycle and lasts only for months; depression implies a great decline in the economic activities that last for years. There is some argument among the economists about the duration for which depression lasts (Sexton and Fortura, 2005).

The characteristics of depression are economic factors that include significant increase in unemployment, decline in availability of credit, decreasing output; sovereign debt faults defaults and bankruptcies, decreased commerce and trade, continued instability in currency values. When depression exists in an economy, the economy shuts down because of decrease in investment and consumer confidence.

Increase Aggregate Demand

Aggregate demand is an indicator of the economy that is suggestive of the consumption power of the people of that country. It is important for economists working in all economies to devise ways that would help result in an increase in the aggregate demand. Moreover, it should be remembered that there are many factors that affect the aggregate demand and these factors should be kept in mind while devising the economic policies. These factors include the marginal propensity of consumption, government spending, interest return rates and the multiplier effect. Apart from this, when strategies to increase the aggregate demand are being considered, they should always be adjusted in a way that would assure that the GDP of the economy remains on the positive side.

Gross Domestic Product of an economy is the sum of government expenditure, net export, consumption and total investment in the economy.

In order for the government to increase the aggregate demand it will have to decrease and taxes and decrease the interest rate. This would result in an increase in investment and thus the increase in GDP. When the people will have to pay less tax, they would have more money to consume more products and thus the aggregate demand will increase.

The government should also increase the income of the people. This would increase the marginal propensity of consumption of the people since they would be able to consume more products, or invest, with the extra money that will be added to their salary. MPC would also increase the GDP of the economy.

The multiplier effects should be used by the government. This implies that the government should invest more in mega projects like the building of a highway etc. This way, the aggregate demand would increase since the contractors would consume the products required for the construction of the road. This would also increase the job opportunities for the people and thus aggregate demand would increase.