The New Phase of the Crisis

The Great Recession was followed by an anaemic recovery in the advanced economies, which threatens to be followed by a double dip or worse now that the  fiscal stimulus measures of 2009 and 2010 have been succeeded by austerity programs.

Now we face a new financial crisis, or at least a stock market correction of major proportions, which may precipitate a new phase of the crisis.

The financial markets seem to suffer from acute schizophrenia, with the bond markets demanding more fiscal austerity in much of the Euro zone, while stock markets are panicking at clear signs of slowing US and global growth.

How should governments be responding to the panic in the markets?

Not, as they have, by caving in to the bond markets.

The G7 Statement issued yesterday called for increased “fiscal discipline” and welcomed the intensifying Spanish and Italian austerity programs. It also ruled out demands on private sector bondholders to take any further haircuts on government debt, beyond the recent actions taken with respect to rolling over Greek debt .

The statement also welcomed the recent US debt deal, which implies more – perhaps significantly more – spending cuts in the near future and certainly means no new stimulus to support a very weak economy stuck with very high unemployment.

There are obscure hints about intervening in the financial markets, but support for market-determined exchange rates was reaffirmed.

What, then, should governments be doing?

The message that seems to come through most of the media – including today’s Globe – is that governments really can’t do very much because they are stuck between a rock and a hard place. Temporary stimulus measures secured a temporary recovery, but at the cost of precipitating an unsustainable increase in public sector debt which now has to be unwound. That is likely to mean a very slow recovery or even worse, but further stimulus would make the underlying problem even worse. Hence we just have to reconcile ourselves to tough times.

This narrative is hard to confront, even though it has serious flaws.

As Krugman, Stiglitz, Dean Baker and many others argue, there is no huge fiscal problem in the US, and certainly no real prospect of a US debt default given that the US Federal Reserve can always finance US government debt. US government bond yields are at record lows. The real US problem is totally dysfunctional politics.  In the short-term, the US needs but will not get a new stimulus program. Over the medium-term, US government deficits and debts could be reduced by sensible health care reform and by raising taxes to levels approximating those in other advanced economies.

In the Euro area as a whole, the debt problem is worse but there is no huge and immediate fiscal problem.  Growth could be maintained if the stronger economies, notably Germany and the smaller northern economies, were prepared to expand government spending and private consumption enough to boost growth in the PIIGS, and to allow for a fall in their trade surpluses so that the weaker economies might be able to export more.  Euro areas institutions need to be changed so that the European Central Bank can effectively backstop Euro government debt and  help governments to lower borrowing costs for those countries which do face serious fiscal problems.

Yesterday’s decision by the European Central Bank to purchase big Euro economy bonds seems to be temporarily working to reduce Euro bond spreads, but looks like another  quick fix.  The underlying issue seems to be that the cost of refinancing  high interest sovereign debt at lower rates would be high,and a political non starter for the “virtuous” Euro economies like Germany which can borrow at much lower rates than Spain and Italy.  The dominant approach  is still to insist on greater austerity in countries with high deficits and/or debt, while ruling out “haircuts” for the bondholders out of fear of sinking big European banks

The key problem,  then, is that the policy shifts we need seem to be political non starters. Which is why the G7 focus remains very much on austerity. Which will make things worse. Which is why the stock markets are panicking.



  • Great post! I would quibble slightly with the notion that bond markets are “demanding more fiscal austerity.” As you note, US government bond yields are at record lows, so bond markets are not demanding austerity there.

    Lenders are (understandably) nervous about a few Eurozone countries, but it is conservative politicians who chose the path of austerity. I think that bond markets would be more relieved by assurances that the Eurozone stands behind the debt of member governments.

    European institutions have failed miserably to provide such assurances. The ECB’s purchases of Italian and Spanish bonds are a significant (and long overdue) step in the right direction, but its absurd decisions to hike interest rates should not escape mention.

  • Christopher Majka

    Another day of market carnage: both Dow-Jones and TSX are down over 300 points. Although every objective economic analysis indicates that the USA must increases taxes on corporations and the wealthy, and introduce a VAT to tackle its acute debt and deficit problems, 60 Tea Party members in the US House of Representatives stymie all such efforts.

  • We knew going into the crisis that it was going to very interesting to see how the morality of neoliberalism played itself out to say nothing of the technical contradictions at the heart of neoliberalism as an accumulation strategy.

    Andrew noted as much in his posts on the Canadian austerity. Canada is the least in need of austerity but has taken that path for reasons that seem only for the need to remain narratively consistent; i.e., to continue the morality play.

    As Galbraith the younger has noted much of this is because none of the leaders in the advanced capitalist zone (least of which is Obama) can bring themselves to accept that growth model was not just flawed but corrupt. The kind of restructuring required amounts to regime change. Yet what the elite want (expect) is a return to the 2006 glide path. It will take quite a bit of drama and trauma (for citizens) before Dorothy realizes she is not in Kansas any more.

  • An excellent post.

    Our income and wealth still depends on the health of the US economy. I think that progressive voices should put together an alternative programme for discussion.

    Unemployed Canadians need a boost from Ottawa: a massive jobs stimulus, more EI (training) options and perhaps infrastructure loans to local governments. Also interest rates are low and Ottawa could finance its deficit directly by issuing bonds to the Bank of Canada and have the Bank manage the money supply (quantity and velocity) more closely.

  • Erin – I agree entirely and have slightly revised the original post to make this clearer.

  • Andrew, Very much agree on the basic tone of this.
    On Europe I would have a few nuances where you write:

    The underlying issue seems to be that the cost of refinancing high interest sovereign debt at lower rates would be high, and a political non starter for the “virtuous” Euro economies like Germany which can borrow at much lower rates than Spain and Italy. The dominant approach is still to insist on greater austerity in countries with high deficits and/or debt, while ruling out “haircuts” for the bondholders out of fear of sinking big European banks

    On the first sentence, if DE etc can borrow at 3% and lend it on at 3% then there is no real ‘cost’. Failure to communicate this to voters was a huge mistake early on (whether a genuine error or part of a cynical campaign to stir up voters anger, we may never know)
    On the second sentence, you don’t actually say this, but it sounds like you disagree with the ‘dominant approach’, i.e. you favour haircuts. I have always been against this (see numerous Social Europe blogs:, while being aware that it is popular, not just on the Right but also on the Left in some quarters. I don’t think it was ever necessary, and I think that events have vindicated the position, because all the talk of ‘private sector participation’ has done is drive up the yields and spread the contagion.
    I do understand that this was politically hard to do, so agree on the political dysfunction point. But in retrospect it would have been quite easy at the start. The prob is that it has got harder and harder and at the same time more and more necessary.

  • The thing I have a real problem with and its starts at the international level, but the main focus being nation. We have been through a great recession and limped out into a zone where it never was clear where we were, at least main street issues. The lack of decent Jobs being at the fundamental core causality. Whether you want to talk about sub prime mortgages, the housing bubble, capital flight and the loss of manufacturing,it all comes back to inadequate demand. So in a mere two days of bad stock prices and we have the whole media and financial industry yelling HELP and governments in two days are already expected to respond.

    I just do not get it, we are going on 4 years of a jobs crisis, yet still no national jobs strategy, or even a hint of one. Instead for main street we have austerity. And then they all wonder why London is burning. The streets sure are paved in gold but as things heat up the Luxury SUV air conditioners just may not be up to the task or sorting it out.

    I could not believe the Globe and Mail ran that article yesterday- No reason for London Uprising! Wow. Austerity, economic slow down, inequality etc etc, but no reason to be on the streets. Hmmmm.

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