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Dealing with the Economic Crisis

The ongoing global economic crisis, if not addressed promptly, has the potential to further destabilize the existing world political and social order.  As History shows, continued public discontent during economic and financial crises often provides a fertile ground for both revolutions and extremist movements.

The recent Arab revolts owe as much to the current economic problems as the rise of Hitler and the Soviet empire did to the Great Depression of the 1930s.  While the jury is still out on the proximate causes of the current crisis, the fact remains that the global economy is still faced with a serious dearth of demand.  This is borne out by the most recent business surveys here and abroad which generally cite lack of customers as the main impediment to business expansion plans.  (In contrast, taxes and government regulations, when also cited as important, appear only as secondary factors.)

But where can this additional demand come from?  Consumers, already heavily in debt, and hit by the double whammy of falling incomes and asset prices, are hardly in a shape to borrow and spend even more.  Likewise, businesses, burdened by massive idle capacity, are understandably reluctant to invest in additional plants and equipments.  And even exports, often a strong source of demand, cannot help in an environment of worldwide decline in national incomes.

That leaves the public sector, as the spender of last resort, the only game in town.  However, instead of more government spending, many are now calling for more austerity to reduce national debt, ignoring the fact that rising national debts have been an effect of the crisis, rather than its cause.  Like prudent households, therefore, governments are also required to live within their means.

This view, however, ignores the fact that, unlike households, governments are responsible for the welfare of their citizens and the stability of their economies.  In addition, governments can tax and print money to achieve their goals of full employment and price stability.  Hence, to combat the current global recession, major governments should borrow and spend freely.   Since these governments can borrow in their own currencies, there is no risk of their ever defaulting on their debts.

This explains why countries such as Japan, UK, and US, which have national debts relative to their national incomes of 240, 100, and 100 percents, respectively, can still borrow at interest rates close to zero.  In contrast, many Euro countries, such as Greece, Ireland and Spain, which have similar debt ratios, have to pay much higher interest rates, simply because they cannot print Euros, a job left to the European Central Bank (ECB).

Should the ECB offer to replace the debts of the Euro members with the newly printed Euros, the European debt crisis will disappear.  However, the ECB takes its orders largely from Germany, which sadly is still obsessed with government austerity and reductions in national debts.  Thus, Instead of using government policy to fight the ongoing economic plague, we are just waiting for it to run its natural course.

Hassan Shirvani, Ph.D.
Professor Cullen Foundation Chair in Economics

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About the Author — Staff

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