Recession and the irony of its solution

As a layman who does not understand much of macro economics except for the easy and lucid explanations given by pundits on news channels, I find it difficult to understand the low interest policies by banks the world over to come out of the recession.

The financial and economic crisis of 2008 which engulfed the whole world resulted in recession. A depression was averted due to the timely and coordinated action by central banks the world over. This however happened due to the loose monetary policy by the Federal Reserve; the US central bank backed by the then Fed Chairman Alan Greenspan, an avid supporter of free markets and the present fed chairman Ben Bernanke, the then director on the fed board. They believed that recessions could be a thing of past and that loose monetary policy could stop the boom-burst cycles of economies. Also markets correct themselves based on demand-supply gaps and the central bank should act only as the facilitator rather than a regulator.

The low interest rate regime resulted in debt-fueled consumption by US exacerbated by the high savings in developing countries such as China, India and the oil rich countries who supported the high consumption of the US. These emerging economies had highest savings during these boom times of the last decade. When this consumption led bubble burst following the bankruptcy of Lehman brothers, the world economy was on the verge of collapse. Keynesian policies took front seat and fiscal action was the order of the day. This however was also combined with loose monetary policy so as to facilitate lending by banks who had taken a hair cut on their balanced sheets.

The thing that I do not understand is that how can low interest rate regime, leading to more lending, revive the economy which is in dire straits due to this debt based consumption? The US is buying its treasuries and non- conventional monetary policies such as quantitative easing are followed and the balance sheets of the central banks are broadened to facilitate lending. How can loose monetary policy be a solution when it was the cause in the first place?

In India, SBI is giving 8% loan to induce spending. Isn’t it similar to debt-fueled consumption? Isn’t it similar to what the US banks did by lending to customers with low credit worthiness? Should we not learn from this and look at other ways to revive the economy?

‘Live within your means’ is one of the famous proverbs. If all people follow this, we would not have the kind of materialism in the world. As Mahatma Gandhi once famously said “there is enough in this world for everyone’s need but not for everyone’s greed”. The crisis of last year clearly embodies this.