Things Fall Apart - The Center Cannot Hold on the World's Economy

Written By ipink edy on Saturday, August 10, 2013 | 5:41 PM

The controlling forces of increased aggregate demand, a predictor of consumer spending, include government expenditure increase, interest rate cut, tax cut, increase in quantity of money, increased investment due to expected future profits among others. Subsequently, the major economies of the world have decided to keep interest rates (government rate, short-term rate) at very low levels so as to increase the quantity of money and supply of loanable funds. Ultimately, this would make money available for people to spend. Additionally, such policies are expected to produce an incremental geometric effect on aggregate demand, consumption expenditure and investment expenditure. Generally, the keeping of government interest rate (called fed fund rate in the U.S) low has a ripple effect in the short run and in the long run. In the short run, it lowers the short-term rates (that is rates on short-term securities like treasury bills, short-term loans from banks, e.t.c) with consequential fall in exchange rates, increases in net export (because of cheaper exports goods compared to imports) and quantity of money or loanable funds in circulation. All these are projections towards boosting aggregate expenditure or demand in the economy.

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A boost in aggregate demand is expected to amplify the real GDP with subsequent price increases and the likelihood of inflation. Similarly, in the long run, long-term interest rate (such as rates on bonds issued by banks or corporation, rates on loans for financing new capital e.t.c), which is also a function of the current and future short-term rates, falls producing a positive chain effect also on consumption expenditure, investment and net exports. Also it perpetuates aggregate expenditure increase thereafter facilitating increased real GDP growth, price and inflation. On the other hand, when government rates increase, short-term and long-term rates all increase with a reduction in consumption expenditure, investments and net exports, real GDP and expected inflation. Contrarily, exchange rate is expected to increase in spite of the fact that exchange rates can also be affected by factors other than interest rate. In summary, changes brought about by the short and long run activities all constitute economic indicators of growth emanating from the scrupulous application of monetary and fiscal policies.

Experience suggests that, the time frame for the realization of these economic indicators of growth due to the impact of fiscal and monetary policies are deterministic (conservative, biased) and not stochastic (random, unbiased). However, in the current recession, these economic indicators are tending to be more stochastic than deterministic. If such trend should continue it would be very difficult for the world to predict when the recession would totally be over for economic or employment boost to return. The assumption of stochastic trend by these indicators is the driving force behind the reason why the huge government spending (the stimulus), the tax & interest rate cuts which are strategies based on economic growth models (Keynesian model and the likes) are failing to yield the expected conspicuous impact. The fact is the economic models on which these policies are made are based on deterministic assumptions of impact which does not allow for much economic contingency.

It is conclusive that the outcome of the models namely the economic indicators are becoming stochastic in nature. Obviously, this calls for optimization of the models using deterministic input (fiscal and monetary policies) producing a stochastic output namely the economic indicators. Otherwise, the impact of government spending, interest rate and tax cuts may not be feasible as expected (both short term and long term) because of the stochastic characteristics of the outcome. Again, the predictability of the economic growth models would continue to present a myopic view of the state of the future economy until the world seeks for optimized economic models with the potential for stochastic outcome. The optimized models should have an appreciable degree of sensitivity to change behaving more like Monte Carlo simulation models. In the absence of such kind of models, there is the tendency for people to continue to blame governments and those in authority and even economists for inaccurate decisions and predictions. Optimist may argue that the outcome of the application of the fiscal and monetary policies is indeterminate with regards to time and this supports the stochastic characteristic assumption of these economic indicators.

Strangely enough, the governments of the major economies in the world currently are torn between recession and inflation. They are more interested in keeping short-term interest rate low primarily to keep their economies from going into deeper recession. The low interest rate puts "breaks" on the economy somehow slowing down the recession. In addition, low interest rate is to create more employment (through increased aggregate expenditure) so as to lower the unemployment rate whilst placing less emphasis on possible inflation rise. Like was said before, these policies have failed to produce the expected gratifying positive outcome.

Unfortunately, countries with lower interest rate present a business environment that turns away foreign investors from investing in their economy producing a substantial net outflow of funds from the country and also exerting a downward pressure on the value of their currency. That is to say a lower interest rate apart from increasing employment produces a weak currency which puts an upward pressure on the country's inflation which in turn puts further downward pressure on the currency. Conversely, high interest rate puts downward pressure on inflation which in turn puts further upward pressure on the currency's value. This substantiates the interdependency between interest rate, inflation and currency rates. The truth is that increased confidence in the world economy has not been persuasive as expected and the world is also witnessing stagnancy in employment and increasing unemployment rates. Nevertheless, if a country's unemployment rate is rising, the demand for imports would decrease which in turn puts upward pressure on the value of its currency. All in all the preceding reflections on the world economy are known economic facts which should create a world of mixed feelings as the predictive models are no longer piquant as expected.

Now, increasing government spending (stimulus, bailout e.t.c) and reducing taxes on income all targeted towards increased aggregate expenditure, real GDP and employment also immensely adds to the budget deficit. The government can pursue conventional measures such as using bonds sale to raise funds to reduce the budget deficit and also unconventional measures namely international borrowing to meet its socio-economic obligations or goals. However, bonds sale calls for future interest payments and principal at maturity and all these combined with international borrowing compounds a government's financial problems and its country's economic problems. Some argue that governments cannot and must not default on its obligations. But a country in serious deficit problems may be compelled to succumb to default in the long run due to mounting socio-economic obligations and debt cum interest payments. Deficits may be passed from one generation to another but that is not sustainable as more "cracks" would be created in the economic ceiling with possible future collapse. Such a state of government would deteriorate the country's credit rating and make it difficult in future to raise funds from bonds sale, domestic and international loan sources.

Next, when these sources of funding are exhausted, the options available for the government would be to increase taxes (predominantly income tax, corporate tax and social security tax), reduce spending and as a last resort print money to pay its creditors. If this action plan is not pursued, the budget deficit would continue to grow with consequences of devaluation of the currencies, reduced investment because of "crowding" effect on loanable funds. Again, this gradually slows down GDP growth and increases unemployment. Rationally, a continued increase in budget deficit must stimulate the interim application of painstaking, austerity measures and fiscal discretionary policies including but not limited to reduction of government spending on goods and services and tax hikes. This should be followed by the monetary policy of an increase in interest rate. The double effect of decreased aggregate demand and the reduction of any threatening inflationary pressure reflected in improved price stability is the expected result. Additionally, it will induce an increase in private savings because of public expectation of higher taxes in future. However, it would certainly lead to increased unemployment rate.

Meanwhile, default of the application of these discretional fiscal and monetary policies could produce devastating consequences. First, to be added to the rising unemployment would be rising inflation predominantly cost-pushed from the rising oil prices culminating in higher raw material prices. Demand-pulled inflation is also possible because of increased quantity of money due to low interest rate. Second, the net effect of the rising unemployment and rising inflation would be stagflation - an unpleasant condition that occurs when an economy experiences high unemployment rate and rising inflation. Economies such as that of the U.S experienced stagflation in late 1970s and early 1980s and this is a sign that no country is exempted from a possible inflation. Furthermore, a high degree of expectation of future immense acceleration in inflation causing inflation "fever" combined with a government's deliberate decision to increase a country's money supply by printing money to pay its bills can create a "sister" inflation called hyperinflation - technically an inflation rate of more than 100% per year. The economic state of Zimbabwe is an example of hyperinflation where people have to carry large sums of money just to buy a roll of bath tissue.

Technically, the major economies in the world system today can conclude that inflation is under control now. However, what the world is witnessing now is an inflation uncertainty "fever" causing people to invest in assets like gold, diamond as a means of hedging against high losses of purchasing power from possible inflation (predominantly stagflation). Gold prices are up now and is likely to go up should the oil price continue to go up. The current world economic situation has created a model of positive correlation between gold and oil prices and it is expected that investments into these commodities would increase in the short run. Logically, the investor diversification into gold and oil securities may be right. Why? Because the rising oil prices and any possible uncertainty rise in tensions in the Middle East & Oil regions besides climatic threats may even escalate the prices of oil to the extreme. The resultant could be stagflation. Real wage rates would be severely affected as inflation rate would greatly exceed nominal wage rate. Under these conditions, the working population would be worse-off even in the midst of increases in wage rate. Presently, the other potential defect of the current gold securities rush is the reduction in funds for the acquisition of physical capital (machinery, factories and technological research) needed for productivity and GDP growth of the economy. That is to say funds which could have been used to increase capital assets for productivity and economic growth or expansion are now being diverted into gold and mineral assets.

Again and interestingly, some proponents may argue that the recent growth in GDP of countries is the resultant of the low interest rate, the multiplier effect of government spending (on goods and services) and tax cuts on aggregate demand. First, the assertions are based on known historical evaluations of these policies. Second, the assertions are true if the economic models on which they are based can be precise in prediction of the magnitude of the aggregate demand increase based on a given magnitude of increased government spending and tax cuts. Now, like it has been said already, the setbacks of these models in this time of recession are their inability to determine when and whether the needed impact of the discretionary polices has been achieved. As a matter of fact, impact assessment of the model-based policies show no convincing results. So the euphoria created by the sentiments of the world's economic rebound may be deceptive judging from the current world economy and the uncertainty that lies ahead. That means recent reports from credible sources like OECD organization about world's economy rebound should be received with caution.

Another dimension very disturbing is the politicizing of fiscal and monetary policies used in running of an economy. This is in particular reference to the incumbent and the opposition party in charge of the affairs of a country. The application of fiscal and monetary policies based on political ideology and not on requisite, sound economic principles can lead to untimely application, wastage of resources and economic failure in the long run. Regrettably, such schisms are still prevalent not only in the socialists and communists world today but in some capitalist as well. The danger here in the case of capitalism is when the economic policy makers (called the Fed in the U.S) come under the control of the incumbent or the opposition inadvertently stripping the economic decision makers of their autonomy. The effect of this is three fold. First, it impedes decision making leading to the production of ad hoc decisions which can hurt the economy. Second, it downplays the ability of the decision makers. Third, it obstructs continuity in policies that gradually leads to the restoration of health to the economy. Realistically, the decision makers may be subject to censoring in terms of their deliberations but anything further than that can lead to manipulation of their policies by the incumbent or the powers that be. So it is necessary that the powers that be desist from seeking much influence and rather work with the decision makers for the common good of the masses.

The Center Cannot Hold

In spite of all these expected developments, currently it is unemployment which is on the minds of people. Though people are concerned about rising budget deficit and possible future inflationary pressures after the current recessionary pressures are over, it is the rising unemployment rate or increased joblessness that is on the minds of people. Unemployment is at the center and unfortunately it is degenerating although the progress of the other economic indicators has been mixed. Factually, governments cannot predict the trend of unemployment in the years ahead. The status quo of the world's economy is that most countries have achieved appreciable GDP growth after several macro-economic policy changes but unemployment rate continues to rise. For example the recent announcement by the federal government of 3.5% GDP growth in the U.S was welcome good news yet unemployment rate now stands at 10.2% and is expected to increase.

The challenge facing world governments is to pursue appropriate strategies that stimulate the business and investments environments for increased employment so as to get unemployment to bottom out with subsequent reduction of unemployment rate from double digits to single digits. For example the U.S government would have to come up with strategies that reduce the unemployment rate from 10.20% to single digits such as 4.5% (almost halving it) without increasing significantly the budget deficit which is a grave threat to economic growth. Interestingly, the strategies by world governments would call for investments to be focused on some virgin sectors of the world economy. The virgin sectors of the world economic system include energy, cleaner or green technology, education, biotechnology, medical field research among others. They are called virgin sectors not because they are new or undiscovered but that there is greater room for research, development and rejuvenation for sustainable economic growth. Pragmatically, the virgin sectors are highly technology-oriented and are likely to yield greater returns besides capital (physical and human) accumulation and productivity increase. Hypothetically, the virgin sectors are likely to be the backbone for an upcoming new green world economy. Though investment in this sector of the new world economy may not yield the expected impact in the short term, it will be the pioneering force for the greening of the world economy and its sustainability. One also should not forget the fact that mankind's continued existence on this earth depends to a greater extent on the greening of the world economy and its sustainability. Propaganda by environmentalist is an attestation to that effect.

In fact, the awareness by the masses of this distinctive sector should spark a new era of career change or professional development pursuits. In the short term, the search for these educational or career changes could spiral frictional and most importantly structural unemployment rates which are inherent components of unemployment. Nevertheless, in the long term, it would lead to the production of the required expertise for the greening of the new world economy. The current unemployment rate even though very unpleasant can be a blessing if the victims of unemployment can take advantage of it to educate, re-train and acquire new skills and expertise in the virgin sectors for the new green world economy. Also, mass pursuits of credentials in the virgin sectors would in turn expand the investment climate helping to reduce unemployment in the long run. The fact is that the new world economic system is heading for a labor force with multi-skill characteristics. The unemployed cannot continue to lament over their situation. They should seek deployment into the virgin sectors by acquiring the requisite skills and education in preparation for entry into the new green world economy. Unemployed people with certain original skills and backgrounds can take advantage of their predicaments to turn their tragedy into triumph.

They can train, educate in the virgin sectors which may or may not be different from their original education or skills so as to become multi-skilled. An engineer who has been laid off can become multi-skilled by training or educating as a business analyst, economist, accountant e.t.c. Experience and statistical data has shown that multi-skilled workers are more productive and it is expedient that companies create incentives for their employees to acquire the needed skills and education to become multi-skilled. A construction worker who has been laid off can educate and re-train ready for the new green economy. According to the U.S Bureau of Labor Statistics occupational outlook, the virgin sectors are expected to grow at least faster than average for all others sectors of the economy [U.S labor Statistics website]. That is why more multi-skilled personnel would be needed in the green sector. Professions such as geoscientist, environmental engineers & scientist, biotechnologist, researchers, ecologists are few examples of few occupations in the virgin sectors. Also, governments should come up with strategies that encourage training and education in the virgin sectors as it seeks to supports the sector by encouraging privatization and liberalization of the sector market.


In conclusion, the world economic system has fallen apart in the last few years in spite of the radical changes in discretional fiscal and monetary policies. The economic models are not yielding results as expected as evidenced from their impact assessment. This is also substantiated by the economic indicators assumption of stochastic characteristics instead of the presumed deterministic nature. Meanwhile, at the center of these economic uncertainty and inconsistencies is the unemployed who have been impacted greatly by the detrimental outcome. Fortunately, there is still hope if they can be undaunting enough to enter the virgin sectors of the economy through the acquisition of the appropriate training and educational credentials. Apparently, the virgin sectors are the driving force for the greening of the new world economy and for its sustainability and the world cannot wait to see this revolution.

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