Is the Recession a necessity?

Shubhaansh Kumar

During the pandemic, in the purely economic sense, money was given away. There was an increase in liquidity in the markets. Now, this influenced the consumption and investment levels, which thereby influenced the aggregate demand, which influenced the GDP. So, even in a tough time like the pandemic when businesses were shutting down and the daily wage laborers had no jobs, when the very backbone of the Indian economy was struggling, the Indian economy did not seem to struggle as much. 

Against a contraction of 6.6% in 2020, the Indian GDP grew by 8.7% in 2021, making up for most of the losses in the first year of the Pandemic. At least on paper. To achieve this growth, a lot of fiscal and monetary policies were put into action to increase the liquidity in the economy and to keep the credit flowing. Going by the Quantity Theory of Money, the price levels are directly proportional to the money supply in an economy. An increase in the money supply should not be having any effect on the GDP of the country, but the Quantity Theory of Money and a direct correlation between liquidity and GDP do coexist in the short run. In the long run, the Quantity Theory takes the win.

If we look at the current state of many economies worldwide, it is pretty evident that the high rates of inflation threaten to nullify the growth in real GDP. There is just too much money sloshing around in the economies. The worst outcome of quantitate easing is wasteful resource allocation.

One of the best ways to understand this is to look at the startup industry and ecosystem. Companies that have been generating a negative cash flow since their inception are still managing to get funded. This increase in liquidity can also be seen as a value destroyer. 

A similar thing transpired during the dot-com bubble of the early 2000s. There were a lot of internet companies with sky-high valuations and sky-high funding that were selling products and offering services that were duds and truly did not have any USP going for them. A recession will guarantee that such value-destroying firms will close their shops and capital will be allocated towards firms that truly add value to an economy and its customers.

At this point, with an increase in wasteful allocation of resources and an increase in the sheer amount of value destroyers, there is an utter need for an awakening of sorts that companies that have been burning through resources stop wasting them and they are better utilized. A recession is bound to do exactly that.

It’s high time that we bring efficiency and prudentness back to the economies worldwide.

Shubhaansh Kumar is a student of BSc (Economics and Analytics) at Lavasa, Pune Campus.