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Responding to financial crisis: are austerity and suffering inevitable?

by Jayati Ghosh Monday, Feb. 04, 2013 at 3:19 PM

Austerity in a recession is counter-productive. Lower taxes and lower wages mean lower demand, lower GDP, lower state revenue and higher unemployment.

"All too often people in countries experiencing financial crisis are told that the road to recovery necessarily involves pain, that fiscal austerity and cuts in spending that adversely affect the lives of ordinary citizens are necessary costs of correction of macroeconomic imbalances and the consequent adjustment that is considered essential for recovery. This is repeated so often that it is now taken as received wisdom by policy makers and civil society alike – yet in fact it is not true at all. It can actually be plausibly argued that in several situations the reverse is correct, that attempts to reverse economic downswings through cuts in public spending are counterproductive and makes matters much worse. This is clearly evident for all to see in the case of crisis-ridden countries in the Eurozone, for example.

And there are also positive counter-examples that show how taking into account the concerns and requirements of ordinary citizens (and paid and unpaid workers in particular) can work as a positive macroeconomic strategy that actually provides a route out of crisis. Sweden provides an example of a country that responded to the financial crisis by explicitly recognizing and attempting to reduce the pressures on workers, and particularly women workers whose needs are often the last to be considered in such periods of crisis. Sweden incorporated measures to maintain or ensure favourable conditions of women’s work and life into its broader economic recovery strategy.
In the early 1990s, Sweden experienced a dual financial and real economic crisis that bears many similarities to the sub-prime crisis in the United States and to the current difficulties faced by some Eurozone countries. Financial deregulation in the 1980s generated significant capital inflows and sparked a lending boom, which was then associated with rapidly increasing consumption, investment and asset price bubbles and heightened activity in the domestic non-tradable sector (particularly in real estate and construction). The Swedish krona was pegged to the US dollar, and so the real exchange appreciated— but this was not the only problem (because even if there were flexible exchange rates, the capital inflows may have nonetheless continued to drive up the nominal exchange). Around 1990, the bubble burst and the boom turned into slump, with capital outflows, widespread bankruptcies, falling employment, declining investment, negative GDP growth, systemic banking crises driven by deterioration in banks’ balance sheets and currency crises (Jonung 2010)."

to read the entire article published in the Real World Economics Review February 1, 2013, click on
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