In the everlasting debates for which economic theory and approach is the most effective, researches unfortunately often remain on theoretical side and tend to forget, that times and circumstances have significantly changed since these theories were introduced. Each national economy is unique, deeply connected with government policy and depends on the plenty different factors. However, “orthodoxy” economy approaches have proven their effectiveness in the past and present positive result of their implementation to some national economies in the present.
Stimulus Approach: Theoretical Background and Practical Appliance
John Maynard Keynes, an outstanding British economist of the early twentieth century, expressed the idea that national economy, regulated by fiscal policy with an emphasis on social spending can help countries overcome recession. He had a talent to develop an appliance of his theoretical ideas to real economic situations. Keynes theory is known as a “stimulus” approach, and along with monetary regulation, described in works of Milton Friedman, it is considered an “orthodoxy” economy nowadays.
According to Keynes economy can be managed effectively by the governments in the short run, rather than relying on the forces of market regulation in the long run.
Current U.S. economic policy, based on the government fiscal stimulus program of 2009, being far from a “magic wand” to the national economy, nevertheless shows effectiveness and slowly leads the country to recovery.
Prerequisites of the stimulus drive for the economy appeared after financial crisis of 2008 that had put national economy into a tailspin. President’s Barak Obama administration had to deal with the need of economy recovery and restoring economic growth.
Obama’s administration was criticized for the stimulus approach by many economists. They doubted an ability of the fiscal stimulus to stabilize and revive the economy and also warned about a potential threat of inflation because of floating the economy with budget money. Nobel Prize winning American economist Paul Krugman supported the stimulus approach of the President’s Obama administration. However, he expressed the opinion that the amount of the bill should have been much bigger in order to overcome all negative social and economic consequences of the recession period. It is obvious that the greater losses from crisis are, the more finances are needed to recover from it.
The U.S. $789 billion economic stimulus bill was spent on infrastructure investment, renewable energy and energy efficiency, advanced vehicles and many other projects. The policy proved its effectiveness, resulting in the short-term boost and creating favorable conditions for the short and middle term investment. “In the longer term infrastructure investment can deliver positive returns to productivity”.
On the other hand, current national debt of the U.S. is now greater than $16 trillion and the budget deficit totals $1.1 trillion in the current year. These factors could have negative influence on the national economy by significantly slowing it.
On the top of the world economic recession many national governments keep up to the austerity approach in the economy. Austerity is opposite to the stimulus and presupposes decrease in public spending, aimed at reducing the budget deficit. Fiscal austerity measures have been recently implemented in a number of European countries. As a result, “Britain is in the midst of the biggest squeeze on living standards since the 1970s”.The largest unemployment rate in the European Union is in Greece and Spain, about 25% in each. Both countries suffer from attempts to deal with government debt by austerity, suggested and introduced by Germany. However, Germany itself along with Britain, France and other countries is forced to make cuts to its national budget as well. Why the fiscal austerity drive is not working as planned in the region?
Analyzing the structure of EU national economies, it becomes obvious that negative austerity influence in each country is caused by different reasons. For example, Greece traditionally had small tax base and large government spending. Consequently, they should have implemented austerity measures much earlier, when the country was in the stage of economic growth. With the current economic crisis budget deficit reduction led to unemployment, social disorder, and massive decrease of the purchase power in the country.
As for the Britain, its recovery from the crisis is extremely slow and according to the latest researches, huge decrease in its productive capacity is caused by the lack of demand. In its turn, domestic consumer demand in a response to fiscal austerity policy, budget and social spending cuts, has declined significantly. In this situation the main problem is to stimulate the demand, which would have a positive influence on the production. The solution appears to be quite simple – increasing of government spending.
In the beginning of 2012 heads of the world’s leading economic organizations including WTO, IMF, World Bank, etc recommended governments to implement growth stimulating economic policies and expressed their negative opinion regarding austerity measures.
According to Keynes, the basic goal of each national economy is achieving full employment. The reason behind this is obvious: the more people work, the more wages they get for their work and the more taxes to the national budget they pay. Less unemployment rate would also allow reducing social payments. According to Neil Bentley, deputy director at the CBI, the UK’s business lobbying organization: “The only way to resolve unemployment in the short term is to pull out all the stops to get the economy moving and business growing”. Here again, stimulus is supposed to come into play.
On the other hand, there were some austerity success stories in the past. One of them is Canadian-style aggressive austerity of 1990s. Measures, implemented by Canadian Prime Minister Jean Chretien worked well. Despite that it was not easy to communicate unpopular decisions to voters, Canadian political leaders managed to succeed.
A Keynesian concept of full employment, mentioned above, has a direct relation to multiplier. “Multipliers are measures of the degree to which the various businesses and households in an economy are interrelated”. Keynes believed that if people would spend all of their income on consumption and none of it on savings, full employment could be reached as a perfect state of economy. “Keynesians wanted to counteract saving by taxing savings to force people to spend more”.
Multiplier theory makes investments an important economic factor. “The proportionate increase in the level of income and employment in the economy depends upon the multiplier”. Thus, increase of investments causes the increase in income and employment. In other words, any cyclical government spending is supposed to increase welfare and prosperity.
Concept of multiplier is important for business and economic sector for several main reasons:
Trade cycle analysis.
Public investment analysis.
Calculation of fiscal policy effects.
Measuring money supply changes in relation to monetary base changes.
Creation of changes forecasts for various economic sectors.
Estimating effects of economic changes.
Measuring an effect of aggregate demand.
As for the latter, Keynesians stated that income is directly proportional to the investments. Increasing in one would create equal increase in the other.
Thus, Keynesian “orthodoxy” economy has proven its effectiveness over the years. If stimulus is applied at the first sign of recession period, it can lead the country to the road of slow and sustainable economic growth. At the same time, stimulus should be implemented as a temporary fix until the economy reaches its peak. Then deficit financing measures should come into play, allowing to improve the entire structure of the national economy.
As to the austerity, according to Paul Krugman, “austerity in depressed economies would deepen their depression”. Current economic situation in the Eurozone has proven this assumption.
However, as each national economy is unique, under certain circumstances each of the stimulus and austerity theories can succeed, as well as none of them could bring desirable result under some other conditions.
Consequently, the most effective approach is a compromise and taking into account economic cycles – in the current U.S. economic policy it is a stimulus. As soon as economy would reach stable growth on the peak of economic cycle, regular scheduled debt paydowns should take place. Such approach was expressed by Keynes and is known as countercyclical fiscal policies.