Countercyclical Policies
No. 3 2016 July/September
Aleksandr Losev

CEO of Sputnik Assets Management, JSC.



Sputnik Assets Management, JSC


e-mail: [email protected]
Floor 10, BTs Pollars, Bldg. B, Derbenevskaya Naberezhnaya 11, Moscow 115114, Russia
E-mail: [email protected]

How to Prepare for a New Technological Mode

Historically, the activity of different groups of people, societies, and nations has increased and decreased and people have experienced various economic fluctuations. Not only is this taking place today, but it will also reoccur in the future due to various political, technological, social, biological, monetary, and natural factors. No country or economy can avoid it. 

Although long-term global economic growth is an aperiodic trend, imbalances may take years or even decades to surface and will need as much time to be eliminated. For the purpose of analysis, such economic fluctuations are grouped into cycles with clearly defined periods of rises and falls.


Factors that cause a rapid growth in business activity or, on the contrary, a sharp decline in production and consumption vary depending on the technological mode and the level of human development. This makes it hard to forecast the beginning of a new cycle using only historical data. Tested recipes are often ineffective if too much time has passed since the previous crisis.             

Decisions on how to smooth over the effects of these cyclic occurrences depend on timely forecasts and detection of the beginning of a new phase as well as assessments about what response—fiscal, monetary, or political—must be effective and timely. 

Both internal and external factors can affect business activity. Internal factors include: demographic and social changes, revolutions, new technological advances, the availability and condition of resources, the growth or decline of financial, industrial, and agrarian reserves, investment fluctuations, and diseases and epidemics. Among the external factors are wars, migration of nations or groups of people, influence of powerful empires or their confrontation, changes in foreign trade and the international economic situation, climate changes, emergence of new energy sources, and cross-border movement of capital.

One would think that it is easier for states to respond to internal factors of changing business cycle rather than external ones, but experience and history have shown that internal factors are usually ignored and misjudged or governments act belatedly or never complete their actions. As a result, structural imbalances may develop in industry and “bubbles” could form, subsequently bursting in certain sectors of the economy for decades, provoking exogenous impacts and excessive activity of foreign states, multinational corporations, and military-political blocs. And then a country may need decades to emerge from its crisis.  

By contrast, external risks, which are more obvious and sometimes more dangerous, force governments and economies to mobilize and act without delay. In fact, Sun Tzu’s The Art of War begins with the following words: “The art of war is of vital importance to the State. It is a matter of life and death, a road either to safety or to ruin.”


Cycles formed by internal and external factors differ in nature and duration.

Short-term cycles usually last three to four years and are generally known as inventory cycles encompassing finances, resources, industrial reserves, and food stocks which eventually need to be replenished. These are known as Kitchin cycles. The most effective way for the government to respond to negative developments and smooth over fluctuations in business activity is to pursue an appropriate monetary policy. Its purpose is to manage money supply and interest rates, reduce or increase the amount of money in the economy, and provide affordable loans and investments. But these are short-term mechanisms that alone cannot spur economic growth in a country. In fact, this is precisely why the European Union, Japan, and the United States have failed for years to cope with the risks of recession and embark on a path of sustainable growth despite zero interest rates and massive printing of money.

Longer cycles last up to ten years (Juglar cycles) and involve changes in production capacities and the human factor. They have four main stages: recovery, growth, recession, and depression. Investment processes gradually stimulate economic recovery. As production and demand grow, new jobs are created, qualification requirements are raised, investments are increased, and industrial enterprises are retooled, boosting labor productivity. All this improves the quality of life, creates better employment opportunities, and spurs aggregate demand.

The first results transform into investment decisions, business activity surges, and the economy starts posting rapid growth. People and businesses step up investment and production, average salaries rise, and consumer spending increases, which creates overemployment and excessive production capacities. The value of money grows, but investment declines. Enterprises have to store their products because aggregate demand falls behind soaring supply. When overproduction and oversupply become obvious, production and employment are cut. Investments plunge sharply, and an increasing number of industrial sites stand idle, while businesses suffer a dramatic fall in profit, face growing losses, and cut employees.   

Production shrinks to the minimum level, while unemployment skyrockets. However, labor becomes cheap and idle production capacities create the potential and latent reserves for future growth. With new investment the cycle repeats itself. 

Such midterm risks can be managed through fiscal and investment policy. The government must reduce the tax burden and encourage investment during depression and recovery. The federal authorities should also withdraw excessive funds through taxes when the economy starts to show rapid growth in order to avoid bubbles, while at the same time building up reserves and savings for a rainy day.   

The Russian economy is in recession. Only long-term investments and government incentives can lead to an economic recovery. Russia’s peculiarity is that its investments come mainly out of profits, with bank loans accounting for only about five percent of total investments. As corporate profits shrink due to low raw material prices, corporations’ financial resources for development shrink as well. 

Russia needs to form its own reserves for development and launch investment loan programs in order to replace external sources of capital with internal ones. The weak ruble hinders industrial renovation, but this is an inevitable price to be paid because monetary and credit policy cannot be effective with a fixed exchange rate, while budgetary policy cannot be effective with a floating exchange rate.  

Finally, long-term cycles, or so-called Kondratieff waves, last forty to sixty years because of uneven scientific, technical, and technological development. The world is now in the final stage of one such long-term cycle. Although some contemporary economists deny the three laws of dialectics postulated by Engels, they clearly show how a civilization develops. The laws depict how accumulated knowledge and scientific discoveries lead to technological revolutions, qualitative breakthroughs in methods and volumes of production, and changes in technological modes when closed-loop production cycles using a certain set of resources, generating and processing capacities, production relations, and distribution of benefits are broken.

To respond to technological challenges during critical stages of long-term cycles, the government must prioritize building up human resources.

It is the system of higher and vocational education that trains a critical mass of specialists needed not only for successful industrial competition, but also for an effective transition to a higher level of civilizational development. The phrase “The Battle of Sadowa was won by a Prussian elementary school teacher” vividly illustrates the role popular education played at the end of the 19th century in facilitating the giant leap forward that made the Kaiser’s Germany and the Russian Empire global economic leaders before World War I.   

The availability of monetary resources is no longer critical at the final stage of a long cycle, as can clearly be seen in modern Middle Eastern countries. Wealthy Saudi Arabia can hardly compare in terms of scientific and technological achievements and contribution to global innovative development not only with Israel, but even with Iran, which is much poorer and has been subject to Western sanctions for a long time. Yet Iran has the biggest share of science and technology education in the world: 47 percent of its university students study natural and engineering sciences, and industrial and construction technologies. The Iranian economy is much more diversified than that of other oil exporters in the region, with only 14 percent of Iranian revenues coming from the oil sector.


In the 20th century, leading countries learned to respond to cyclic challenges quite effectively by conducting a countercyclical policy. Examples abound: Germany’s reconstruction after World War II, Roosevelt’s New Deal, Soviet industrialization in the 1930s, the Marshall Plan, and the Japanese post-war economic miracle, when a dirigiste economic policy and massive investments in industry and infrastructure quickly led war-torn economies out of stagnation and devastation. Their countermeasures varied in terms of effectiveness and the results largely depended on the development of industry, labor resources, and the financial system. It became obvious at the time that a combination of monetary incentives, technological modernization of industry, and economic restructuring produced the best results. This recipe is still relevant in Russia and elsewhere. 

However, the emergence of the global market, which weakens the sovereignty of states, makes it harder to manage national economies and prevent their overheating and crises, for this would require key financial centers, and monetary and political authorities to synchronize their activities at all times.  

Accelerating over the past two decades, globalization has affected all world economic processes and necessitated corrections to the theory, methodology, and practice of monetary-credit and fiscal policies. Borders have become transparent for cash flows and a new system of feedback has emerged that makes cash flow management and regulation more effective. The other side of globalization is increased sensitivity of financial markets to any impact, including so-called verbal interventions by the heads of the Federal Reserve System and the European Central Bank, statements by politicians, and electoral cycles in key states, which inevitably affect, albeit slightly later, the business climate and economic activity of different countries. 

 The strengthening of the U.S. dollar and the simultaneous fall of commodity prices, the shrinking of international trade, and the reverse movement of capital from emerging to developed markets create negative feedback in the global economy. As a result, the U.S. Federal Reserve System, as a global issuer whose activities affect all global markets, plays a key role in countering negative cyclical phenomena.   

The purchase by the Federal Reserve of $1.7 trillion in debt bonds and pecuniary assets from banks and corporations with electronic cash as part of its quantitative easing program started in November 2008 not only stopped the global financial crisis, but also significantly reduced the risk of recession in leading economies. Other programs launched by the Federal Reserve and the European Central Bank, which followed suit by starting to buy up EU government securities, prevented the spread of the debt crisis, the collapse of the euro zone, subsequent economic stagnation, and a dramatic decrease in the trade surplus with the EU’s key trade partners, including China and Russia.     

Because of incorrect or untimely action, or even intentional interference and misjudgment, decisions made by the monetary authorities may cause dramatic upheavals on financial markets. Those decisions could set off a chain reaction of economic decline in different parts of the world that are not connected with each other, spark global crises, or even result in serious political consequences for some states.

There are several graphic examples of such upheavals: the Asian financial crisis of 1997-1998, triggered by a mass outflow of foreign capital and the devaluation of national currencies earlier pegged to the U.S. dollar, which dramatically impacted natural resource prices, shook emerging markets and precipitated Russia’s and Argentina’s default on their debt. The global financial crisis of 2008-2009 was caused by a shortage of liquidity due to a significant decrease in money supply from the Federal Reserve. The financial crisis fueled a five-fold growth of interest rates in three years in the United States and contributed to the U.S. housing bubble. Problems in the European banking system, which financed budget deficits in peripheral EU countries, fueled the European debt crisis of 2010-2012 caused, among other things, by falling asset prices and the untimely response by the EU and the European Central Bank.      

Experts still wonder whether a political or a dogmatic reason was behind the Federal Reserve’s decision in December 2015 to widen the base interest rate range, which essentially meant a tighter monetary policy and a new monetary cycle. Since the U.S. fiscal authorities raised key interest rates in late 2015 before the economic situation started to show real signs of improvement globally and specifically in U.S. industry, which had demonstrated the worst corporate profit performance in years, the Federal Reserve’s decision fueled strong turbulence on financial and commodity markets. The Fed’s decision also sent stocks plummeting around the world, created more problems for China, pushed oil prices down to a new all-time low in January 2016, and triggered a global shift of capital flows towards the United States and their mass flight from risks. As a result, negative economic tendencies increased outside the United States. The risk of currency wars and competitive devaluations rose in countries that are key U.S. and EU trading partners.


Currently, two very important monetary and commodity super cycles are coming to an end.

The world crisis of 2008-2009 and the European debt crisis of 2011-2012 burst financial bubbles, creating a gap of $9 trillion in the U.S. banking system alone, followed by a credit crunch and deleveraging aimed at reducing the percentage of debt for economic entities and households. The Federal Reserve had no choice but to start filling this gap with money and low loan interest rates practically at zero.    

Attempts by leading central banks to offer unprecedented monetary incentives after the latest economic meltdown pushed interest rates to an all-time low or even below zero, something that had not happened for decades. Interest rates will remain low until the credit crunch is overcome, while economic growth in developed economies will remain feeble and the risk of recession high.  

 And yet this cannot continue indefinitely. In the future the value of money will have to grow, interest rates will return to normal levels, and demand for financial resources will increase, thus setting off a new monetary cycle. The world must start getting ready for that already now.   

A similar situation can be observed in commodity markets. Natural resource prices have continued to rise for almost two decades. The rapid development of the Chinese economy, which accounted for one-third of global growth over the last ten years, was spurred by material-intensive industries. Demand for commercial metal, construction steel, electricity, and hydrocarbons in China and growing economies in South and Southeast Asia and Latin America generated extra demand for raw materials and sustained global investment flows to the mining, steel manufacturing, and oil and gas sectors. The global economic slowdown in the wake of the 2008 crisis triggered a deflation of the commodity bubble. By January 2015, the fall of commodity prices began to look irreversible and led to the flight of capital and reduced investment in the resources sector. The “shale oil revolution” in the United States put an end to the era of high oil prices.

Economists link the end of the commodity cycle, the decline in the consumption of ores, metals, and hydrocarbons, and the fall of prices for practically all natural resources to the lowest levels in years with economic transformations in China, which actually started this super cycle in the early 2000s. 

But China is only the most vivid example. There are many signs indicating the end of the last stage of industrialization, extensive industrial growth in developing countries, and the era of traditional material-intensive production.  

Plagued with structural disproportions and dependence on raw materials, the Russian economy is experiencing all the consequences of the end of the two super cycles.

The global economic slowdown and redistribution of capital flows between developed and developing countries provoke a real fight for markets and worldwide economic competition between the main financial centers like the United States, China, Japan, and the EU, formal associations such as APEC, TPP, OPEC, ASEAN, MERCOSUR, as well as countries, multinational corporations, and large companies.  

All of them are competing for markets, capital, resources (including labor), investor attention, and technological standards that will set new benchmarks and ensure leadership in the future. The consequences of these processes and possible decisions by governments and the central banks of countries deeply involved in global trade will not only be economic, but also political. Such consequences can both change the structure of the world economy and create a new system of centers of influence and power, thus destroying the model of unipolar globalization.

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The world is about to enter a new technological mode. As the energy and material intensity of production continues to decline, there will be a new qualitative leap in development. A mild monetary policy conducted by governments around the world ensures that economies will be injected with money to facilitate greater investments in innovative industries of the future.  

This expectation of a new long-term cycle means in part that the global economy is about to hit bottom, while the cycle is coming to an end. It also signifies that Russia might have a unique chance to consider taking a qualitative leap as part of a new industrial revolution rather than catch up with the outgoing technological mode, since many existing industries will become economically senseless and have no future. Preparing human resources for such a leap may end up as the main goal and quintessence of Russia’s current countercyclical policy.