The world economy needs deficit spending
In the aftermath of World War II, industrialized countries experienced handsome economic growth rates for some three decades. The party came to an end in the 1970s with so-called stagflation, ensuing sluggish growth and rising unemployment rates. In this period, the neoliberal paradigm replaced post-war Keynesian economic policies, which gave precedence to fiscal policy. In parallel with the transformation and significant expansion of the financial system, monetary policy with a special and excessive focus on price stability and central bank independence began to dominate political and economic discussions while fiscal policy was dismissed almost altogether and relegated into oblivion by most economists and policymakers.
The performance of the world economy after the 1970s, however, was rather disappointing in comparison with the post-war economic expansion, and moreover, the neoliberal period witnessed numerous financial crises with an ever-increasing contagion effect. The ultimate blow to the world economy came in 2008-09 with a global financial crisis not seen in magnitude since the Great Depression of the 1930s. Already harshly criticized for the economic fluctuations and financial instabilities for which it had paved the way since the 1980s, the failure of the neoliberal economic paradigm was laid bare by that massive-scale financial catastrophe. Preaching for so-called free markets and small-scale government as much as possible, not to mention abhorring government intervention in the economy for almost three decades, industrialized countries scarred by the financial crisis intervened heavily in financial markets to save those mainly responsible for the global economic crisis, namely financial institutions. While these institutions had recklessly swollen their balance sheets and made enormous gains in the process, tripling their share of world gross domestic product (GDP) over the last two decades prior to 2008, mounting systemic and financial risks culminated in the global financial crisis of 2008-09 and the near collapse of financial institutions.
Economic theory and, particularly, free-market ideology suggest that economic crises are good in the sense that they help remove the rotten tomatoes in the system, resulting in a better allocation of capital and labor in the economy. What we experienced, however, was in stark contrast to what had been preached, as governments immediately stepped in and did whatever they could with taxpayer money to save the financial institutions that were the main culprits of the global calamity. But while pumping billions, and even trillions, of dollars, euros and pounds into the financial system was good enough to save the financial system, it was barely effective in reviving aggregate demand in the global economy.
After almost a decade of nearly futile struggles to resuscitate the world economy through monetary policies fortified with a good dose of government intervention in the so-called all-knowing free markets, and at the same time schizophrenically denying the efficiency of fiscal policies, it is now apparent that neoliberal economic policies, too, have failed tremendously. Note that even less government spending, or austerity, was hailed by neoliberal economists and policymakers as good and responsible economic policy in an era wherein overproduction and under-consumption are the new norm.
Actually, while worried corporations - and customers - have been sitting on piles of money and are not willing to invest or consume, governments can do the job of kick-starting the economy through more spending. Deficit spending is definitely not the panacea for the long-term economic problems the world economy faces today. However, the short-term is also of paramount importance in the sense that actual production and employment levels have a significant influence on potential production and future employment levels in an economy through the hysteresis effect and market imperfections. Therefore, instead of not trying to decrease spending and being austere in an era of under-consumption, deficit spending is the responsible way of governing.
* Assistant professor of economics at Istanbul Medipol University
The performance of the world economy after the 1970s, however, was rather disappointing in comparison with the post-war economic expansion, and moreover, the neoliberal period witnessed numerous financial crises with an ever-increasing contagion effect. The ultimate blow to the world economy came in 2008-09 with a global financial crisis not seen in magnitude since the Great Depression of the 1930s. Already harshly criticized for the economic fluctuations and financial instabilities for which it had paved the way since the 1980s, the failure of the neoliberal economic paradigm was laid bare by that massive-scale financial catastrophe. Preaching for so-called free markets and small-scale government as much as possible, not to mention abhorring government intervention in the economy for almost three decades, industrialized countries scarred by the financial crisis intervened heavily in financial markets to save those mainly responsible for the global economic crisis, namely financial institutions. While these institutions had recklessly swollen their balance sheets and made enormous gains in the process, tripling their share of world gross domestic product (GDP) over the last two decades prior to 2008, mounting systemic and financial risks culminated in the global financial crisis of 2008-09 and the near collapse of financial institutions.
Economic theory and, particularly, free-market ideology suggest that economic crises are good in the sense that they help remove the rotten tomatoes in the system, resulting in a better allocation of capital and labor in the economy. What we experienced, however, was in stark contrast to what had been preached, as governments immediately stepped in and did whatever they could with taxpayer money to save the financial institutions that were the main culprits of the global calamity. But while pumping billions, and even trillions, of dollars, euros and pounds into the financial system was good enough to save the financial system, it was barely effective in reviving aggregate demand in the global economy.
After almost a decade of nearly futile struggles to resuscitate the world economy through monetary policies fortified with a good dose of government intervention in the so-called all-knowing free markets, and at the same time schizophrenically denying the efficiency of fiscal policies, it is now apparent that neoliberal economic policies, too, have failed tremendously. Note that even less government spending, or austerity, was hailed by neoliberal economists and policymakers as good and responsible economic policy in an era wherein overproduction and under-consumption are the new norm.
Actually, while worried corporations - and customers - have been sitting on piles of money and are not willing to invest or consume, governments can do the job of kick-starting the economy through more spending. Deficit spending is definitely not the panacea for the long-term economic problems the world economy faces today. However, the short-term is also of paramount importance in the sense that actual production and employment levels have a significant influence on potential production and future employment levels in an economy through the hysteresis effect and market imperfections. Therefore, instead of not trying to decrease spending and being austere in an era of under-consumption, deficit spending is the responsible way of governing.
* Assistant professor of economics at Istanbul Medipol University
Last Update: May 08, 2016 22:58