The Lesson of the Post-Crisis Slump

Almost all major economies had great difficulty dealing with the aftermath of the 2008 financial crisis—high unemployment, low growth and, for some, solvency concerns, and high interest rates on public debt.

Clearly, then, the best way to avoid the terrible problems that arise after a financial crisis is not to have a crisis in the first place. How can you do that? In part, one might hope, through better regulation of financial institutions. We turn next to attempts at regulatory reform.

Austerity Britain

An election in May 2010 led to a shift in power in Britain, with a Labour Party government replaced by a coalition dominated by the Conservative Party under the new prime minister, David Cameron. The new government was firmly committed to the austerity side of the great post-crisis policy debate, and it changed policy accordingly.

Unlike Greece or Ireland, Britain wasn’t under any immediate pressure to slash its budget deficit. Like the U.S. government, the British government was still able to borrow cheaply despite its large deficit. And the British economy was, if anything, even more depressed than the U.S. one, with fewer signs of recovery. The Cameron government believed, however, that preemptive cuts in public spending combined with some tax increases were necessary to preserve investor confidence and also that such cuts could boost the economy by improving confidence.

How have these policies performed? As of mid-2012, the experiment in austerity had yielded disappointing results. British economic growth was weak—in fact, considerably weaker than in the United States, even though U.S. performance was lackluster. And as Figure 18-9 shows, the hoped-for surge in business confidence that austerity measures were supposed to generate had failed to materialize.

Business Confidence in Britain
Source: Grant Thornton, UK Business Confidence Monitor.

Quick Review

  • Economic damage from the financial crisis of 2008 was both large and prolonged. Aftershocks from the crisis continue to shake the world economy.
  • The world’s two largest economies, the United States and the European Union, suffered severe downturns, shrinking more than 5%, followed by relatively slow recoveries. The severe slump and the slow recovery were very bad news for workers.
  • The persistence of economic difficulties after the 2008 financial crisis led to severe solvency concerns for several European countries. A fierce debate erupted over whether fiscal stimulus or fiscal austerity was the right policy prescription.

Check Your Understanding 18-4

  1. Question

    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
    Standard macroeconomics the kind we've discussed in this book - would say that faced with an economic slump, a government should adopt expansionary policies to increase aggregate demand. France, however, was doing just the opposite, responding to a weaker economy with a contractionary fiscal policy that would make the economy even weaker. This shows that the French government had aligned itself with the austerity view, believing that it was more important to assure markets of its solvency than it was to support the economy.