The persistence of economic difficulties after the 2008 financial crisis led to fierce debates about appropriate policy responses. Broadly speaking, economists and policy makers were divided as to whether the situation called for more fiscal stimulus—expansionary fiscal measures such as more government spending and possibly tax cuts to promote spending and reduce unemployment—or for fiscal austerity, contractionary fiscal measures such as spending cuts and possibly tax increases to reduce budget deficits.

The proponents of more stimulus pointed to the continuing poor performance of major economies, arguing that the combination of high unemployment and relatively low inflation clearly pointed to the need for expansionary policies. And since monetary policy was limited by the zero bound (a concept we discussed in Chapter 16) for interest rates, stimulus proponents advocated expansionary fiscal policy to fill the gap.

The austerity camp took a very different view. Strongly influenced by the solvency troubles of Greece, they argued that the common source of all the problems were high levels of government deficits and debts. In their view, countries like the United States that continued to run large government deficits several years after the 2008 crisis were at risk of suffering a similar loss of investor confidence in their ability to repay their debts. Moreover, austerity advocates claimed that cuts in government spending would not actually be contractionary because they would improve investor confidence and keep interest rates on government debt low.

Each side of the debate argued that recent experience refuted the other side’s claims. Austerity proponents argued that the persistence of high unemployment despite the fiscal stimulus programs adopted by the United States and other major economies in 2009 showed that stimulus doesn’t work. Stimulus advocates argued that these programs were simply inadequate in size, pointing out that many economists had warned of their inadequacy from the start. Stimulus advocates further argued that warnings about the dangers of deficits were overblown, that far from rising, borrowing costs for Japan, the United States, and Britain—nations that, unlike the troubled European debtors, still had their own currencies with all the flexibility that implies—had fallen to record lows. And they dismissed claims that spending cuts would raise confidence as mainly fantasy.

By 2014, the intellectual debate seemed to have gone mostly against the advocates of austerity. Research at the International Monetary Fund and elsewhere seemed to support warnings that austerity policies depress output and employment, especially when there is little room for interest rates to fall. Interest rates in countries that borrow in their own currencies remained low despite years of high budget deficits—and as we saw in Figure 17-8, even eurozone governments with high levels of public debt saw their borrowing costs drop sharply once the European Central Bank moved to end fears of a cash crunch. The shift in the intellectual debate did not, however, lead to much change in actual economic policies.