by Merlin Hernandez

A look at the value of a recession to the economy might provide some insights to whether recession is necessary. In periods of protracted expansion, consumer optimism is high and so is spending. The downside is that the savings rate plummets as prudence is set aside in the euphoria of plenty. Consumption rates grow steadily while capital formation stagnates. The foundation of economic stability is thus undermined by the imbalance between consumption and savings. But the economic climate will remain bullish, propped up by low interest rates and increased national debt that continues to favor consumption, increase inflation, and obliterate capital.

An important strategy to reverse the trend and shunt consumption and savings back into balance is to encourage fiscal responsibility by increasing interest rates as a means to reduce spending. As interest rates rise, people are scared into curtailing their spending habits which favors saving over consumption, making capital formation possible once more. In this sense, a cycle of recession is necessary to the business cycle to slow spending and build capital reserves.

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