Economists usually don’t conduct experiments, but events can create them. This happened after 2007, as the United States and the European Union responded very differently to the financial crisis and recession. Data now indicates that our country’s approach had better results. But, as ever in economics, that conclusion has qualifications.
Let’s review what happened. Multiple factors motivated excessive risk taking in mortgage lending and derivative securities. Cracks opened in mid-August 2007, when commercial paper markets seized up in Europe. The European Central Bank and U.S. Federal Reserve pumped in tens of billions of dollars over a few days.
While problems increasingly emerged, the public took little notice until Wall Street bank Bear Stearns went bust in March 2008. Then things deteriorated rapidly until a crisis blew up, with Lehman Brothers seeking bankruptcy Sept. 15. The Fed intervened to prop up many firms, including AIG, one of the world’s largest insurers.
The Bush administration instituted its Troubled Asset Relief Program, going to Congress for a large appropriation. It also included $280 billion in economic stimulus funds in the 2009 budget.
Once Barack Obama was inaugurated president, he asked Congress to approve the second half of Bush’s TARP bailout plus $789 billion in stimulus, of which some 35 percent was in the form of temporary tax reductions. Although Obama’s inauguration took place four months into the fiscal year, measures he requested contributed about $240 billion to a record $1.4 trillion deficit that year.
At the same time, the Federal Reserve increased the monetary base by record amounts, pushing its targeted interest rate down to a quarter point. Later, in its quantitative easing program, the Fed added even more money.
Europe reacted differently. Officials first insisted this was a U.S. problem and that European institutions and economic policies were sound. Soon this clearly was not true, and Europe followed us into financial crisis and recession.
In both areas, output and employment fell sharply. But the European Central Bank, which conducts monetary policy for the 19 euro-using nations, hesitated to lower interest rates, like the Fed. Ditto for the Bank of England and the largest EU economy still outside the euro.
In fiscal matters, there were moves to austerity, cutting spending and often increasing taxes, to limit budget deficits driven by recession. Deficits did increase for many.
See the contrast? The United States reacted to a financial crisis and recession with expansionary monetary policy and, at first, a sharp increase in the deficit, although state-level spending shrank. Europe tried to minimize government deficits and expanded its money supply much less.
Which was better?
Here real gross domestic product, the inflation-adjusted value of output, hit a high in the first quarter of 2008, as things began to fall apart on Wall Street. GDP fell 5 percent over the next year but then inched back up, passing the 2008 peak in early 2011. Now it is 10 percent above that crest and 15 percent above the 2009 trough.
In Europe, recovery was much slower. Just last month EU real output finally regained its 2008 high. In other words, its recovery has lagged the United States by five years. Total lost production far exceeded the U.S. over the eight years.
In unemployment the picture is similar. In both areas, it rose as problems unfolded in 2008, but in the United States more steeply. It topped at 10 percent here in late 2009 but has declined steadily since then. Europe’s rise lagged but persisted longer, not peaking at 10.9 percent early in 2013. By then, our country was down to 7.5 percent unemployment. Now we are at 5.4 percent nationally with Europe still at 9.6 percent. Numbers of jobs follow a similar pattern.
The obvious lesson seems that stimulus is a better response to financial crisis and recession than austerity. Liberal Keynesian economists like Paul Krugman and Brad Delong are hammering this point.
So are such “anti-Austerians” correct? Yes, although I am skeptical about the efficacy of even looser money. And to the degree that I am Keynesian at all, I am much more cautious than Krugman.
One does not have to believe in Keynesian economics, however, to favor the general approach of the United States. In 2008, the Bush administration and Fed implemented more pragmatic scrambling than deliberative economic theory.
No matter what school of thought, most economists believe a central bank should never let the money supply collapse as the Fed did from 1929 to 1933 and should never let an economy fall into deflation. Similarly, even if skeptical about fiscal activism, most economists recognize that major downturns in government outlays during recessions tend to make the recessions worse. The austerity approach doesn’t look particularly good right now.
But this general conclusion needs some qualification.
The populist success of presidential candidates Donald Trump and Bernie Sanders reflects broad feelings that the economy has not improved at all for many Americans. They are right. Most of the gain in national income over the past seven years has gone to a very small fraction of the income scale. Most households are not much better off, if at all. The one saving grace is low inflation.
In Europe, the 28-member EU has not recovered nearly as well as our country. Nor has the eurozone. But Germany, the champion of austerity now running a budget surplus, is doing very well, with unemployment below that of the United States.
Income distribution is a long-term problem, but it is still better to be producing 15 percent more goods and services and with low unemployment.
St. Paul economist and writer Edward Lotterman can be reached at email@example.com.