European Perspectives on the Recession
Edited by David Howden
Chapter 8: Fiscal Stimulus, Financial Ruin
Fernando Ulrich With few exceptions, the current European sovereign debt ordeal is a direct consequence of Keynesian policies aimed at tackling the financial crisis. The wrong medicine can not only be ineffective, but also, in many cases, fatal. Before attempting to demonstrate why and how the Keynesian fiscal stimulus is a misconceived idea and a recipe for disaster from the onset, we must put matters into context. With that in mind, let us understand the sequence of events that led to the current predicament. Triggered by the subprime crisis and the eventual burst of the housing bubble in the US in 2007, the financial turmoil soon spread to Europe and the whole world, leading central bankers to unprecedented measures to avoid a total economic collapse. By late that year, the credit crunch had forced monetary authorities to take immediate actions to safeguard liquidity. At the next G-20 meeting, world leaders reached a consensus with regards to the need for additional measures to avert a global economic collapse. The Washington Summit’s declaration suggested the ‘use of fiscal measures to stimulate domestic demand to rapid effect’ (G-20, 2008). The then British prime minister Gordon Brown was heeding the advice of Paul Krugman, that year’s Nobel economics prize winner, and leading the world to take appropriate and immediate fiscal measures. Professor Krugman in turn praised the prime minister’s leadership stance as a probable ‘savior’ of the world’s financial system while urging world leaders to avoid ‘thinking too small’ with respect to fiscal stimulus...
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