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Economic Expectation Defines Reality

I have been hooked about discussing every nook and cranny relating to business and economy for a while now.

economic-expectation-defines-reality

An expectation is a term people use to set our benchmark on things that will come in the future. An Individual's Expectation will rarely come true if there is insufficient effort to make the intention come true. So, an expectation is mostly a daydream for people to chitchat about in their daily lives. But from an economic perspective, an expectation will be the downfall or rise of a country's economy.

In all economic theory, a ceteris paribus is almost always a requirement. People are too chaotic to predict, and experts agree that people will make the best decision even though this concept will not happen in reality. But the theories proved to be valuable for governments as a measurement to see if at least the result will be beneficial.

For example, John will save his money for a year to buy a house. But when the house prices seem lower, John immediately takes a loan to purchase it at a lower price. And John is right. This decision makes him feel better about himself. Therefore, his ability in his workplace increases, and he gets a raise as a result. This example may be an exaggeration, but it can be a reality in some cases.

“Reality is frequently inaccurate.”

— Douglas Adams, The Restaurant at the End of the Universe

Different Continents, Same Problem

economic-expectation-defines-reality

The Weimar Republic and Zimbabwe are the by-product of the same problem—hyperinflation. Many factors contributed to how they fell because of inflation, but people's mindset was the same. Their people foresaw that the prices would keep falling, so they locked their resources. And in economics, individuals keeping their labor and buying potential is a big no-no.

Because the prices were falling, people were not spending their money. Now, the idea that prices are decreasing and the value of money lowering is a bit counterintuitive. But experts can explain this concept with a simple equation. Money equals output. When the value of money is low, the output should be the same. But when the output stays healthy, and money doesn't follow it, the output couldn't keep up with it. Then, equation shatters. And the economy crashes.

When there's no money flowing around, people had no incentive to work. The economy was coming to a halt, and the governments were doing everything they can to solve it. The Weimar Republic solved it by making a new currency altogether, and Zimbabwe took the same route by using other country's currency for everyday tasks. These people needed an incentive to do something.

Even an Expanding Economy Can Experience Stagflation

economic-expectation-defines-reality

In the 1970s, stagflation struck the USA. Stagflation is a combined term of stagnation and inflation. Therefore, the definition of stagflation is: economy stagnating while the money keeps inflating. This idiom is one of the significant economic problems economists feared. And even though the USA may have the best economic experts, the government failed to comprehend it.

The root of this stagflation is the same as the Weimar Republic and Zimbabwe. The government tried to pump up the nation's productivity by giving more incentives to the people, but the output can no longer increase. After that, the equilibrium between money and output crashed. And the situation deterred the people from spending their money because of the Expectation of prices going lower.

To resolve this trouble, The Federal Reserve issued a controversial policy. They increased the interest rate and decreased the number of incentive people received. Unemployment increased to 10%, but the wheel of the economy was running again. But doing nothing would worsen the economy much more than just increasing the unemployment. Like everything else in this world, there is a side-effect.

Depressing Thoughts Worsen the Great Depression

economic-expectation-defines-reality

After a series of unfortunate events, the stock market crashed in 1929. Because of the widespread effect of this event, economists today use the word recession rather than depression. The Great Depression stopped the economy from running. People were confused because they don't know what happened to the economy. Protests were beginning to spark in the USA.

In times of uncertainty, people were not interested in spending their money. They expected that the economy would become worse and worse so their money now would be worthy again in the future. This notion created a cycle of not spending money because of fear, and prices kept falling because of no buyers. The Federal Reserve tried to help people by giving them a loan but giving more money caused more trouble. Even the Fed didn't know what to do at the time.

The solution to this problem is a tragic one. The economy of the USA was receiving an uplift because of the second world war. The allied forces needed lots of resources to keep the war favoring them, and the USA was the major contributor to them. The USA opened employment to produce more output to win the war, and people were getting paid again.

“America had been a boom-and-bust economy going into the Great Depression - just over and over and over, fortunes were wiped out, ordinary families were crushed under it.”

— Elizabeth Warren

To Foresee Is to Make Real

The economy is the collective effort of many people. If people are afraid of something, the economy will be the first to take impacts. Recession, stagflation, and hyperinflation could be much worse or better, depending on the people's actions. Governments should understand that educating people about economics may save their nations in the long process.

© 2020 Azka Fariz Fadhilah