Glopolis is a non-partisan, non-governmental organization which focuses on the analysis of economic globalization, trade, development, agriculture and climate change.

„The Financial Crisis Five Years On. Stimulus vs. Austerity“ Study

Glopolis issued a new study on financial crisis and a debate between fiscal austerity and fiscal stimulus.

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"The Financial Crisis Five Years On. Stimulus vs. Austerity" cover

The global financial crisis is widely regarded as the worst financial crisis since the Great Depression. What began as a housing bubble and a rise in foreclosures in the U.S. quickly moved to Europe and turned into a global economic and financial crisis that also severely affected many developing countries, as has been documented in many reports.

Five years after the global crisis erupted, the world is seized by a debate between fiscal austerity and fiscal stimulus that shows no sign of disappearing any time soon. Billions of euros and dollars have been spent on so-called recovery packages, and central banks have cut interest rates and pumped more money into the economy to overcome the economic crisis. A sharp increase in public debt has then progressively shifted the policy priority from stimulus to fiscal consolidation, especially in Europe.

Are the consolidation policies cutting too much too soon, thus creating unnecessary contraction, or is the need for tight fiscal discipline, balanced budgets and managed money more important? Opponents of austerity worry about contractionary effects on the economy. Opponents of stimulus worry about indebtedness and moral hazard. According to American economist Paul Krugman, the crisis and slump have been a testing ground for economic doctrines – demand side versus supply side.
Demand siders saw this as a slump caused by inadequate spending resulting largely from the persistence of debt from the bubble years and an overall decrease in demand that pushed the USA and Europe into a classic liquidity trap. Other economists insisted that it was actually some kind of supply shock instead. Either they had an Austrian story in which the economy’s productive capacity was undermined by bad investments in the boom, or they claimed that high taxes and regulation had undermined the incentive to work.

Krugman argues that in order to decide which story was right one has to look at the behavior of interest rates and inflation. For advocates of a demand side story, they would also believe that even a large monetary expansion would have little inflationary effect. Supply side story believers expect lots of inflation from too much money chasing a reduced supply of goods. Yet the predicted inflation still has not materialized.

Many developed countries are in a liquidity trap with interest rates at or near zero, high unemployment, unsustainable debt and low growth. Political debate has moved on from the need for fiscal stimulus to the recognition that fiscal deficits have grown substantially and need to be reduced. Policy makers are again facing a dilemma. Should governments be spending more if there are concerns about the effectiveness of fiscal stimulus?

The financial crisis started in the West, but developing countries were also affected primarily by trade and financial flows. These countries made considerable efforts to mitigate the effects of the crisis despite the fact they did not have the resources to stimulate the economy and social safety nets in place in more developed countries. BRICs and other new, fast growing countries have emerged from the global financial crisis remarkably well. The global balance of economic power has shifted from West to East.

Here you may download the study The Financial Crisis Five Years On. Stimulus vs. Austerity (PDF, 570 KB)

glopolis 2014