- The authors show that, contrary to popular belief, decreasing US interest rates causes the currency to weaken. During the Global Recession, the US dollar rose strongly in reaction to the Federal Reserve’s monetary policy easing(s). Furthermore, the currencies that use the dollar as a hedge have lost the most value versus the dollar as a result of accommodative monetary policies implemented during the Global Recession.
- A flight-to-safety impact evident in the currency risk premium component of exchange rate movements was one avenue that produced this rise. The currencies that use the dollar as a hedge have lost the most value versus the dollar as a result of the flight to safety effect in response to Fed easings. The cross-currency heterogeneity in the total dollar appreciation is based on these disparities in effects across currencies. The authors show that during the Global Recession, a US monetary policy easing that dropped US future rates by one percentage point resulted in an increase in estimated investor risk aversion of between 28 and 43 percent.
- The Fed’s easings cut the predicted future path of US inflation in comparison to other countries, which pushed the dollar higher.
- The shift of financial wealth from the United States to the rest of the globe is another facet of the dollar’s “exorbitant burden” that was sparked by these Fed easings. A one-percentage-point cut in US forward rates resulted in a huge drop in US net foreign asset positions, amounting to up to 18 percent of US GDP. The loss caused by changes in asset prices alone accounted for as much as 17% of US GDP.
- All of the empirical findings may be explained by a scenario in which the Fed’s accommodative monetary policy during this era, calendar-based forward guidance, sent a strong signal that future US GDP growth will be lower than projected by economic actors. A one-percentage-point reduction in US forward rates resulted in a negative revision of US GDP growth projections of between 0.71 and 1.03 percentage points.
The indirect expansionary effect that the Fed intended when promising that policy rates would remain low for the foreseeable future was eclipsed by the consequences of this signaling channel. When economic agents have more uncertainty about economic fundamentals than about monetary policy, and when policy is conducted in a way that leaves these actions potentially open to being interpreted as signals about the central bank’s true sense of the economy, the theory predicts that this signaling channel will dominate. During the Global Recession, these prerequisites were met, according to the report.
What happens to the dollar’s value during a downturn?
Readers’ Question: What happens to a currency’s value during a deep recession and high inflation?
There is no hard and fast rule for what happens to a currency’s value during a deep recession; nonetheless, a currency’s value is likely to fall as the country becomes less appealing as a place to invest. The UK, for example, saw a huge depreciation when the Great Recession began in 2008.
Between 2007 (before the start of the Great Recession) and July 2009, the Pound Sterling plummeted by more than 25%.
The US dollar index (which measures the value of the US dollar against a trade-weighted basket of other currencies, such as the Euro and the Yen) has varied, but it has been relatively stable since the recession began.
Although the United States was in recession in early 1980, the value of the dollar soared during this time.
In the 1980s, the UK had a similar experience. In 1980, there was a quick appreciation in Sterling (which was one reason contributing to the 1980/81 recession.)
Economic theory behind the value of a currency in recession
Assume that one country, such as the United Kingdom, has a recession that is more severe than all of its competitors. What can we anticipate the currency to do?
Interest rates and the recession We should expect UK interest rates to decline in comparison to other countries if the UK enters a recession. This would make the UK less appealing to save money investors. Hot money is anticipated to depart the UK in search of greater interest rates in other countries. People will sell Pounds and buy other currencies if they shift money out of the UK, causing the value of Sterling to plummet. As a result, we might predict a currency depreciation in the event of a recession.
Evaluation
1. Inflation is likely to fall during a recession. Lower inflation will aid the country’s competitiveness, and this will likely raise demand for the currency, causing it to appreciate.
2. A currency’s value is influenced by a variety of circumstances. If the UK had a high current account deficit, for example, we may expect the currency to be under pressure from the trade deficit. Sterling’s depreciation in 2008 was due in part to the UK’s trade imbalance and lack of competitiveness. However, because Germany has a big current account surplus, there may be less downward pressure on its currency (the Euro) if the country goes into recession.
Why does the dollar appreciate during a downturn?
Rather than depreciating during the Global Recession, the dollar rose statistically in response to the Federal Reserve’s policy easings, resulting in huge wealth transfers from the United States to the rest of the globe.
Why should prices rise in the midst of a recession?
Lower aggregate demand during a recession means that businesses reduce production and sell fewer units. Wages account for the majority of most companies’ costs; in fact, wages account for 70% of the average company’s expenses. If a company can’t cut wages for fear of lowering worker productivity, it won’t be able to cut per-unit manufacturing costs very much. As a result, the company can’t lower prices very much because pricing must remain above manufacturing expenses in order for the company to break even and stay in business. So, what does it all mean?
When demand falls, prices tend to remain stable. Even when there is less demand for output in the economy, they remain high. Because enterprises are unable to swiftly or easily cut wages, the negative demand shock causes a recession, with output decreasing and unemployment growing as a result of the mass layoffs.
The government could try to mitigate the negative demand shock as a means to get around this slow adjustment process. Such efforts may be able to hasten recovery by avoiding the need for price adjustments to return the economy to full employment output levels.
What is valuable in a downturn?
During market downturns, precious metals such as gold and silver tend to do well. However, because demand for certain commodities tends to rise during recessions, their prices tend to rise as well.
There are several ways to invest in precious metals. Purchasing coins or bars from a vendor or coin dealer is the most straightforward option. While this is not the same as purchasing a security, it is technically equivalent to any other choice.
If you want to invest in precious metals, look into exchange-traded funds (ETFs). These funds are pools of money invested in a single industry, in this case the precious metals market. If you’re saving for retirement, you might also invest in a gold IRA.
What is the current worth of the dollar?
The value of a currency, such as the dollar, is reduced when it is devalued. This is referred to as dollar devaluation in the case of the dollar.
Because the purchase power of a currency decreases as it devalues, you can buy less with it.
Why did the dollar rise in 2008?
Safe haven flows bolstered the dollar to the extent that global investors sold other currencies against the dollar to seek sanctuary in Treasuries. The unwinding of carry trades was a second source of upward pressure on the dollar.
What is the economic consequence of the recession?
Traditional fiscal stimulus analysis focuses on the short-run effects of fiscal policy on GDP and employment creation in the near term. Economists, on the other hand, have long recognized that short-term economic situations can have long-term consequences. Job loss and declining finances, for example, can cause families to postpone or forego their children’s college education. Credit markets that are frozen and consumer spending that is down can stifle the growth of otherwise thriving small enterprises. Larger corporations may postpone or cut R&D spending.
In any of these scenarios, an economic downturn can result in “scarring,” or long-term damage to people’s financial positions and the economy as a whole. The parts that follow go through some of what is known about how recessions can cause long-term harm.
Economic damage
Higher unemployment, decreased salaries and incomes, and lost opportunities are all consequences of recessions. In the current slump, education, private capital investments, and economic opportunities are all likely to suffer, and the consequences will be long-lasting. While economies often experience quick growth during recovery periods (as idle capacity is put to use), the drag from long-term harm will keep the recovery from reaching its full potential.
Education
Many scholars have pointed out that educationor the acquisition of knowledgeis important “Human capitalalso known as “human capital”plays a crucial role in promoting economic growth. Delong, Golden, and Katz (2002), for example, assert that “Human capital has been the primary driver of America’s competitive advantage in twentieth-century economic expansion.” As a result, variables that result in fewer years of educational achievement for the country’s youth will have long-term effects.
Recessions can have a variety of effects on educational success. First, there is a large body of research on the importance of early childhood education (see, for example, Heckman (2006, 2007) and the studies mentioned therein). Because parental options and money drive schooling at this stage (pre-k or even younger), issues that diminish families’ resources will have an impact on the degree and quality of education offered to their children. Dahl and Lochner (2008), for example, indicate that household income has a direct impact on math and reading test scores.
Second, a variety of factors outside of the school environment influence educational attainment. Health services, for example, can remove barriers to educational attainment, from prenatal care to dental and optometric treatment. After-school and summer educational activities have an impact on academic progress and learning in the classroom. Forced housing dislocationsand, in the worst-case scenario, homelessnesshave a negative impact on educational outcomes. Economic downturns obviously affect all of these factors on educational performance. In 2008, 46.3 million individuals were without health insurance, with over 7 million children under the age of 18 being uninsured (U.S. Census 2009). We can expect even more children to struggle with their schooling as poverty (nearly 14 million children in 2008) and foreclosures (4.3 percent of home loans in the foreclosure process1) rise.
Finally, families who are trying to make ends meet are frequently pushed to postpone or abandon aspirations for further education. According to a recent survey of young adults, 20% of those aged 18 to 29 have dropped out or postponed education (Greenberg and Keating 2009). According to a survey performed in Colorado, a quarter of parents with children attending two-year colleges expected to send their children to four-year colleges before the recession (CollegeInvest 2009).
College attendance is costly if it is postponed or reduced. Not only does attending college lead to higher earnings, lower unemployment, and other personal benefits, but it also leads to a slew of social benefits, such as improved health outcomes, lower incarceration rates, higher volunteerism rates, and so on (see, for example, Baum and Pa-yea (2005) or Acemoglu and Angrist (2000)).
Opportunity
There’s no denying that recessions and high unemployment restrict economic opportunities for individuals and families. Individuals and the greater economy suffer losses as a result of job losses, income decreases, and increases in poverty.
To give just one example of missed opportunities, recent study has indicated that college graduates who enter the workforce during a recession earn less than those who enter during non-recessionary times. Surprisingly, the findings also imply that the income loss is not only transient, but also affects lifetime wages and career paths. “Taken together, the findings show that the labor market effects of graduating from college in a terrible economy are big, negative, and enduring,” writes Kahn (2009). She finds that each 1 percentage-point increase in the unemployment rate results in an initial wage loss of 6 to 7%, and that the wage loss is still 2.5 percent after 15 years.
Non-college graduates will most likely do badly. While unemployment has grown for all demographics throughout the recent crisis, individuals with less education and lower incomes face significantly greater rates than others.
Job loss
The unemployment rate has risen from 4.9 percent in December 2007 to 9.7 percent in August of this year during the current recession. About 15 million people are unemployed right now, more than double the level at the onset of the recession, with nearly one out of every six workers unemployed or underemployed. About 5 million individuals have been out of job for more than six months, making up the greatest percentage of the total workforce since 1948.
Losing one’s employment causes obvious challenges for most people and their families. Even once a new job is taken, the income loss can last for years (often at a lower salary).
Although the research on the effects of job loss is far too large to discuss here, Farber’s evidence is worth highlighting (2005). Farber concludes that job separation is costly, based on data from the Displaced Workers Survey from 2001 to 2003. 2 “In the most recent period (2001-03), approximately 35% of job losers were unemployed at the next survey date; approximately 13% of re-employed full-time job losers are working part-time; full-time job losers who find new full-time jobs earn about 13% less on average than they did on their previous job…”
Job loss has an impact on one’s mental health in addition to their income and earnings (see Murphy and Athanasou (1999) for a review of 16 earlier studies). It’s also worth noting that how one does during a recession is determined by a multitude of things. When compared to other age groups, older employees are disproportionately represented among the long-term unemployed.
Economic mobility
As previously stated, intergenerational mobility or the lack thereof can exacerbate the effects of recessions.
Through a variety of processes, poorer families can lead to less opportunities and lower economic results for their children, whether through nutrition, school attainment, or wealth access. As a result, a recession should not be viewed as a one-time occurrence that strains individuals and families for a few years. Economic downturns, on the other hand, will affect the future chances of all family members, including children, and will have long-term effects.
Private investment
Investments and R&D are two of the most obvious areas where recessions can stifle economic progress. Economists have long acknowledged the importance of investment and technology as driving forces behind economic growth. 4
Investment spending and the adoption of innovative technology can and do decline during recessions. At least four causes have contributed to this. First, a downturn in the economy will reduce demand for enterprises’ products as customers’ incomes fall, diminishing the return on investment. Second, enterprises’ ability to invest will be hampered by a lack of credit. Third, recessions are periods of greater uncertainty, which may cause businesses to cut down on spending “They may be less willing to experiment with new items and procedures because they are “core” products and production techniques. Finally, the relationship between human and physical capital must be considered. Technology is frequently integrated in new physical equipment: as output and employment decline, fewer fresh equipment purchases are made. As a result, workers are less able to put existing abilities to use, and there is less of a need to learn new ones “current employees to be “up-skilled,” or hire new employees with new skills.5
Figure C depicts non-residential investment growth during each of the last four recessions, as well as a more specialized category of equipment and software (thus excluding structures). Annualized quarterly non-residential investment averaged 4.7 percent from 1947 to 2009, whereas investment in equipment and software averaged 5.9 percent. Investment falls sharply during recessions, as shown in the graph. It also demonstrates the severity of the present slump, with total non-residential investment down 20% from its peak in the second quarter of 2009.
The repercussions of reduced investment levels are evident. Decreased levels of economic production in the future are a result of lower capital investment today. Poorer levels of physical investment can lead to lower productivity and, as a result, lower earnings. 6 The consequences will linger long after the present recession has officially ended.
Entrepreneurial activity: Business formation and expansion
Apart from the general drop in investment activity, recessions, particularly those with a credit crunch, such as the current one, can stifle small firm formation and entrepreneurial activity.
There are various ways that recessions might stifle the establishment and expansion of new businesses. To begin with, it is self-evident that new businesses require new clients. Because a slowing economy equals less overall spending, those considering starting a new firm may prefer to wait until demand returns to typical levels. Second, new businesses necessitate the addition of new debtors and investors. Lower wages and wealth levels may make it more difficult for new businesses to recruit individual investors, and credit limits may limit private bank financing.
“The credit freeze in the short-term funding market had a disastrous effect on the economy and small enterprises,” according to a recent analysis from the US Small Business Administration (SBA 2009). The usual production of products and services had virtually stalled by late 2008.” According to a study of loan officers, conditions for small-business commercial and industrial loans have been dramatically tightened.
Not only do recessions make it more difficult to establish a new firm, but they can also derail struggling new businesses. There could be a slew of new firms (and business models) popping up.
els) that might be successful in normal times but can’t because to a lack of demand or credit. In 2008, 43,500 businesses declared bankruptcy, up from 28,300 in 2007 and more than double the 19,700 that declared bankruptcy in 2006. (SBA 2009).
The influence of the recession can also be observed in the number of initial public offerings (IPOs). Firms use the funds earned from initial public offerings (IPOs) to grow their operations. There were just 21 operating company IPOs in 2008, down from an annual average of 163 the previous four years (Ritter 2009). 8 Furthermore, the median age of IPOs in 2008 was slightly greater than in previous years, indicating that the capital flood is going to the more established companies.
It’s tempting to believe that recessions just delay the establishment of new businesses, and that delayed plans will eventually be implemented. However, many new enterprises have a limited window of opportunity to get started. Furthermore, innovative new businesses frequently build on previous technological and innovation platforms. A delay in one business may cause delays in many others, causing a cascade effect across a wider variety of businesses.
Key Points
- Price is significant to marketers because it reflects their evaluation of the value customers see in a product or service and their willingness to pay for it.
- Changing the pricing has a significant impact on the marketing strategy, and depending on the product’s price elasticity, it can also alter demand and sales.
Key Terms
- Customer perceptions of relative pricing (cost to possess and use) and performance are referred to as value (quality)
- Marketing mix is a business instrument used in product marketing that is typically used to determine a product’s or brand’s unique selling point. The four Ps (price, product, promotion, and place) are frequently used interchangeably.
Should you cut prices during a downturn?
Price cuts are common during recessions, but for a business to prosper in spite of a terrible economy, a more holistic plan is required.
It’s difficult to set prices during a downturn or recession. Too often, businesses just lower their pricing in order to increase sales. During challenging economic times, however, the appropriate pricing can help a company compete and even grow. Here are some recession price dos and don’ts:
- Define the value that you provide to your clients. Any understanding of the value you provide to your clients provides you more control and assurance over your price. Inquire about your consumers’ opinions on your products and services.
- Create a range of low-cost to high-cost options. Bundle your products and servicesand price them accordinglyto satisfy both cost-conscious and value-conscious clients without having to decrease prices.
- Reduce inefficiencies and cut costs at your organization. In any economy, streamlining your company’s operations and expenses is beneficial. Reducing pricing to increase sales will not benefit your company in the long run.
- Invest in new ideas to provide something different. Put money into R&D so you may develop new products and services that will provide you more negotiating power with clients and help you grow your business. When customers are looking for something fresh to help them improve their financial prospects during or after an economic downturn, innovation gives you an advantage.
- In order to compete, you must offer discounts on your products or services. Engaging in a price war with your competitors without first altering the value of your product or service will only lead to a downward pricing death cycle in which no one wins.
- Reduce the cost of your high-value services and goods. Keeping high-value products priced appropriately during a recession is a better strategy than focusing on selling more low-value products and services.
- Play poker with consumers who are motivated by pricing. When cost-conscious clients threaten to go elsewhere, either (1) boldly point out the unique value your product and service provides, which justifies the price you charge, or (2) let the customer go to your competitor and harass him instead.
Holden Advisors’ cofounders, Reed Holden, DBA, and Mark Burton, are prominent pricing experts.