Why Does A Few % Change Cause Such Catastrophe

[mommysboy]

Why is it that such seemingly small changes in GDP (perhaps just 3% in UK) can result in massive recessions, with perhaps an additional million or more jobs being lost in the UK for instance. Is it because economies are so highly leveraged.

Idiot's guide type answer would be appreciated.

[PeaceBlondie]

I am an idiot. I have asked why any GDP figure, adjusted for cost of living/inflation, has to increase by 0.1%. No answer so far. What is wrong about stability?

The current economic downturn, measured in terms other than GDP - such as employment - seems unrelated as a cause and effect. But I am an idiot.

[lannarebirth]

Growth is required to service ever increasing debt which in recent years has been the driver of growth. Debt expansion can not go on indefinitely and generally retrenchments come every 4.5 years or so (normal business cycle) and recessions every 10 years or so. In the Greenspan era rather than take small downturns in stride as part of the natural order of things, instead more debt was created. It would appear the bill has become due.

[CaptHaddock]

Why is it that such seemingly small changes in GDP (perhaps just 3% in UK) can result in massive recessions, with perhaps an additional million or more jobs being lost in the UK for instance. Is it because economies are so highly leveraged.

Idiot's guide type answer would be appreciated.

I don't know much about the UK economy, but it's probably not so different from the US economy in this respect. First, 3% is a lot, not a little. Huge, actually. The US econonmy will probably be down 2% or 3% for 2008. And we lost 1.8 million jobs. The US work force is about 154,000,000. So, the loss of jobs is about 1.1% which is probably a little bit less than the loss of GDP. However, both the decline in GDP and loss of jobs accelerated a lot in the last quarter. In addition to jobs actually lost, there is a loss of earned income due to both reduced hours, reduced wages per hour, and reduced benefits.

Actual losses of these kinds have destructive effects on the economy in a variety of ways. Those whose income has been reduced or eliminated certainly spend less. But the vast majority who continue to work and receive the same income spend less too, because they fear losing their jobs in the near future. This negative consumer effect is especially important in consumption-based economies, such as the US, where it accounts for 71% of the economy. By contrast, I think domestic consumption accounts for less than 50% in export-driven China.

Businesses that earn less, spend less and sooner or later cut costs by reducing head-count. Banks and other lenders as less willing to lend to either businesses or households. Now you've got a vicious circle of reinforcing effects.

In the current recession by contrast with others in the postwar period, there is another huge effect at the same time, the credit crisis. As a result of the bursting of the housing bubble, there have been huge losses to lenders. When the stock market blew up from 2000 to 2002 the effect on the economy was not so large because most of the losses were not borrowings that had to be repaid. Also, a relatively small percentage of households owned stocks as a significant percentage of their net worth. It's a very different picture for houses, where almost 70% of US households owned their house at the peak of the bubble. And about 65% of those households owed money on the house. The lending of money for the housing bubble was accomplished to a large degree by entities other than regulated banks. These largely unregulated lenders did not have sufficient reserves for the scale of the losses that have emerged. So the losses cascade to the lenders' lenders. Because of globalization of financial services in recent years the losses have spread very widely, affecting villages in Norway and banks in Germany and many others. This leveraging by the unregulated lending sector is much bigger than the actual banking sector. So, you are correct that the recent high level of leveraging will have a strongly aggravating effect. This is the basis for the frequent comparisons to the Great Depression, which was a routine recession (panic) made very severe by the runs on the then unregulated banking sector.

Edited December 14, 2008 by CaptHaddock

[think_too_mut]

Why is it that such seemingly small changes in GDP (perhaps just 3% in UK) can result in massive recessions, with perhaps an additional million or more jobs being lost in the UK for instance.

Start from here: 7% growth doubles the economy over 10 years.

[Khun Jean]

It is not only that, but if inflation percentages are calculated differently then before it gives people false hopes. Instead of tightening the belt people spend more because everything is perfectly 'normal'. If inflation was still calculated the 'old way' like we all expect it to be then this years inflation is around 10-12%. This would have warned people a few years ago.

Alas, the conclusion is, you are being lied to. It was just building up like a real bubble, only nobody was aware of it because the numbers were manipulated. Just google 'inflation' and 'substitution'.