stimulus vs austerity sovereign doubts the fourth in our series of articles on the financial crisis looks at the surge in public debt it prompted and the debts about how quickly governments should cut down economists are an argumentative bunch. Yet before the crisis most found common ground in the notion that fiscal stimulus was on obsolete relic. Monetary policy seemed wholly capable of taming the business cycle. Government efforts to increase spending or cut taxes to battle unemployment would only much things up. When crisis struck in 2008, however, that consensus evaporated. the frightening speed of the economic collapse spurred governments to action, in spite of economists’ doctrinal misgivings. In 2009 many countries rolled out big packages of tax cuts and extra spending in the hope of buoying growth. This stimulus amounted to 2% of GDP on average among the members of the G20 club of big economies. Among Barack Obama’s first step as president in 2009 was to sign the American Recovery and Reinvestment Act, a stimulus plan worth $831 biliion, or almost 6% of that year’s GDP, most of it to be spent over the next three years.
Keynes to the rescue
Supporters of stimulus looked to the ideas of John Maynard Kaynes, a British economist. Depression, his acolytes reasoned, occurs when there is too much saving. When too many people want to save and too few to invest, then resources (including workers) fall idle. Firms and families might save too much because of financial uncertainly or because they are rushing to deleverage to reduce the ratio of their debts to their assets.
In normal times central banks would try to spur growth by adjusting interest rates to discourage saving and encourage borrowing. Yet by early 2009 most central banks had reduced their main interest rates almost to zero, without the desired result. Overindebtedness, some surmised, might have