The Fiscal Policy Experience Since the Great Recession

By Philip Arestis, University of Cambridge, and Malcolm Sawyer, Professor of Economics, University of Leeds. Originally published at Triple Crisis

In the period before the global financial crisis, macroeconomic policy was dominated by monetary policy; fiscal policy had become, at least in academic circles, largely dismissed. Governments still operated fiscal policy in the sense that budgets were presented and adjusted in light of economic circumstances. The countries of the Economic and Monetary Union of the European Union were supposedly constrained in the size of their budget deficits, though the constraints were frequently not observed.

With the global financial crisis, attention quickly swung to fiscal policy. Initially through late 2008 until early 2010, the automatic stabilisers of fiscal policy were allowed to function and budget deficits rose; there was additionally some relatively modest and temporary discretionary spending and tax reductions. At least the mistakes of the 1930s of cutting public expenditure in the face of recession were initially avoided, though unemployment rose substantially and the largest declines in GDP since WW2 were seen. It should have been self-evident that the upward swings in budget deficits were a direct result of the recession, and that attempts to reduce the deficit through austerity would undermine recovery. The sensible response should have been that, as recession caused the rise in budget deficit, recovery would bring a fall in the budget deficit. However, governments were panicked into a drive to “eliminate the deficit” whether or not the economic conditions were appropriate for deficit reduction. The panic was fostered by a “debt scare” with a focus on the often large rises in public debt, which occurred between 2008 and 2010. The idea was promoted that budget deficits were in some sense too large prior to the financial crisis, even though there was scant reason to think they had in any sense been unsustainable.

The “debt scare” was strongly influenced by the work of economists Carmen Reinhart and Kenneth Rogoff (for example, their book This Time is Different: Eight Centuries of Financial Folly) and their promotion of ideas that high public debt led to slow growth. Of particular significance was the notion that there was a cliff-edge with a sharp decline of growth for a debt to GDP ratio above 90%. Apart from noting that there is a wide range of ways of measuring public debt and which liabilities are included, there is no recognition that government has substantial infrastructure and other assets, which have often been funded by borrowing. Causal observation should have shown that the relationship did not always hold—a notable example being UK’s public debt ratio of over 250% of GDP in 1945, followed by development of the welfare state, nationalisation and a period of sustained growth. Theoretical analysis would suggest that it is slow growth and low investment which lead to high debt-to-GDP ratio, rather than the reverse. A substantial set of doubts on the work of Reinhart and Rogoff, especially their 2010 paper “Growth in a Time of Debt,” relates to the serious statistical errors in their work as demonstrated by Herndon, et al. (2014).

In the UK, it became politically convenient for the Coalition government of 2010 to 2015 to blame the previous Labour government for budget deficits, not just after the global financial crisis, but also prior to that (when the budget deficit in 2007/08 was 2.5% of GDP). In the euro area the finger was pointed at failures to enforce the Stability and Growth Pact with its aims of a balanced budget over the cycle with deficits limited to a 3% ceiling: in the relatively boom years of 2002 to 2007 budget deficits averaged 2% of GDP.

In the UK, the government put in place, in 2010, an austerity programme focused on expenditure cuts rather than tax increases and forecast to achieve a balanced budget (cyclically adjusted) by 2015. A failure to achieve that balanced budget was followed (after the election of a Conservative government) by the Code for Fiscal Stability, seeking to bind government to a balanced budget. This was abandoned two years later (following the UK’s vote to leave the EU). The Economic and Monetary Union responded with a tightening of its approaches to fiscal policy by the adoption of a “fiscal compact” (which has now been adopted by 25out of the 28 member countries of the EU) with its requirements for a “balanced structural budget.”

The “debt scare” and the pursuit of a “balanced structural budget” add to the atmosphere and pursuit of austerity. The “debt scare” leads to the view that “something must be done” or dire consequences will follow. There is little evidence to support the debt scare, yet plenty of evidence that austerity hits economic activity negatively. In a similar vein, what evidence is there that a balanced structural budget is feasible—that is, that it is possible to achieve a budget in balance and the economy operating at its “potential output”? The general record is that governments have not been operating with a “balanced structural budget.”

There were, throughout, obsessions with the size of the budget deficit—and using the scale of deficits and debt as ways of forcing through austerity and attacks on public services. The question should always be whether the fiscal position is supportive of a high level of economic activity, and the budget deficit should be large enough to support that level of economic activity—but not larger. When private sector demand is low, then potential savings are high and will become available to support budget deficit of an appropriate size. Debts accumulated from appropriate deficits can similarly be readily accommodated. Instead of fretting about the debt ratios and striving to always balance the (structural) budget, the focus should be on why a deficit is often necessary for a reasonable level of economic activity.

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  1. TK421

    A substantial set of doubts on the work of Reinhart and Rogoff

    That’s a nice way of saying that they’re frauds, ignoring examples that disprove their thesis.

  2. JEHR

    The Professor needs to know that the government spends into the economy and thus creates deficits that put money into the private sector. Too much debt in the private sector is dangerous; whereas, debt in the public sector stimulates the economy and can create jobs.

    1. TK421

      But–but aren’t you worried that the Federal Reserve will break Congress’s kneecaps for not paying off its debts???

  3. Synoia

    Too much debt in the private sector is dangerous; whereas, spending in the public sector stimulates the economy and can create jobs, as long as the spending is denominated in the local fiat currency.

    Borrowing US Dollars to finance imports results in a loss of sovereignty.

    1. Yves Smith Post author

      Norway has a massive sovereign wealth fund and spends from that as well as taxing. Chile is reported to have sluggish growth, if you had bothered to Google,

      1. Grumpy Engineer

        I did Google it. Over the past 20 years, Chile’s GDP growth rate has been better than that of both the US and Japan, where deficits have long been higher. This was particularly true before 2008, where Chile ran surpluses over 5% of GDP while experiencing GDP growth rates around 5% per year. It’s really only in the past year that Chile has experienced a sharp slowdown, primarily driven by a reduction in exports to China.

        Many people in the comment section here treat it as axiomatic that budget deficits are necessary for economic growth, and that bigger deficits are better. But there are counter-examples out there. Norway and Chile have recently experienced growth with surpluses. The US did so back in the 1950s. Japan and Venezuela are counter-examples of a different flavor. Japan has run large deficits with ultra-low interest rates, and their “lost decade” of tepid GDP growth has run nearly 27 years. Venezuela is running enormous surpluses in the middle of an economic meltdown.

        If the axiom is true, people should be able to explain why all of these counter-examples happened.

        1. John Zelnicker

          @Grumpy Engineer – The answer to your final query is found in the sectoral balances approach.

          See this for starters:

          See here for the math behind sectoral balances:

          Prof. Bill Mitchell, who writes the billy blog, also has a lot of posts explaining the accounting and the theory behind the sectoral balance approach:

          Basically, there are three sectors that contribute to GDP; the government (federal) sector, the private sector (firms and households), and the foreign sector (imports and exports). The combination of deficits and surpluses for each sector must add up to zero.

          1. Grumpy Engineer

            Hrmm. I looked at the math in the Wikipedia article, but I don’t buy equation #2. It says that “households can use total income (Y) for the following uses…“, where Y is GDP. That’s not true. Households don’t get to use all of GDP. They only get to use 42.9% of GDP, per

            Also, it looks like these equations would only be valid for a fixed number of dollars. As best I can tell, they fail to account for any new dollars (created by the Federal Reserve) that are used for additional spending in both the public and private sectors. It doesn’t have to be savings dollars that are borrowed and recirculated by the government.

            Indeed, new money from the Fed explains why we have more dollars in circulation that ever before, despite accumulated trade deficits that have sent a great many billions of dollars on a one-way trip out the door.

            If you’re willing to print new dollars, there are lots of ways they could be injected into the economy. Deficit spending by the federal government isn’t the only path.

            1. John Zelnicker

              @Grumpy Engineer – Equation #2 is correct, the text is wrong. It should say households and firms, as in the domestic non-government sector.

              Since these equations are essentially a snapshot of the monetary flows in our economy, they do not explicitly show the effect of new money. However, it shows up in the change in G-T over time.

              You are correct that the government does not need to borrow and recirculate savings. The whole system of issuing Treasury securities equal to the deficit in order to “sanitize” it (make it non-inflationary) is a holdover from the days of the gold standard. Now it serves mostly as a welfare scheme for the rich.

              The trade deficits aren’t exactly a one-way trip. Foreign owned dollars that are not being used currently to pay for our exports are generally placed in a savings account called Treasury Securities, just like you might transfer money you don’t need right away from your checking account to your savings account. Thus, the government can use those dollars for its spending.

      2. FluffytheObeseCat

        So, massive, and anomalously well-managed natural resource wealth is the key. In order for the anomalously well managed bit to work, you probably need a small, ethnically and socially homogeneous population. Perhaps most critical is a managing elite that maintains commonality with, and a sense of responsibility towards, the main population.

        Otherwise, its deficits galore in order to have a half decent society. I’d run deficits in that case for sure. But, the author was right to wrap up with the fundamental question of …. why? Why should it be this way?

    2. Grebo

      It’s actually about the sum of the current account, private credit creation and government deficit, which is to say the overall flow of money into (or out of) the economy from the only three sources (sinks).
      Countries with a large current account surplus—like Norway, Chile and Germany—can get away with a government surplus. In most countries there is a negative trade balance (money is draining out of the economy) and people are trying to reduce their debts (more money draining) so the government should be running a deficit (turning on the taps) to make up the difference.

      1. Grumpy Engineer

        If the issue is money draining out of the economy, I can think of four paths to re-inject some:

        [1] Lower interest rates to encourage more borrowing from the Federal Reserve. Wall Street definitely likes this approach, but based on the tepid economic performance (and rising inequality and indebtedness) of the past 8 years, I’m not convinced it’s good for everybody else.

        [2] Engage in deficit spending to force money into the economy. Federal contractors definitely like this approach, but based on the under-performance of the ARRA stimulus act, I’m not totally convinced here either. Notably, lots of people were far removed from the federal spending and saw little benefit, while others reaped big profits. IMO, this disparity in outcomes helped Trump get elected.

        [3] Give newly-printed dollars directly to state and local governments to use as they see fit, whether that be infrastructure, pay hikes, new services, or debt reduction. Effectively block grants with no strings attached.

        [4] Give newly-printed dollars directly to individual citizens to use as they see fit, whether that be to buy stuff, travel, pay debts, or whatever. A quasi-UBI, if you will, though likely not rising to the level of a “livable wage”.

        Right now we do a mix of #1 and #2, but fewer and fewer of those dollars are actually ending up in the hands of citizens. This is plainly evident in numbers tracked by the Fed: The economy is technically growing, but actual people are being more and more left out.

        Have we ever tried #3 or #4? I’m only aware of the ~$600 rebate issue back in the Bush days, which was much smaller than the $2500 per person of the ARRA.

        1. Grebo

          Banks borrowing from the Fed [1], then lending to the Treasury, injects a small (relative to the size of the borrowing) net amount into the financial sector. Very little of that leaks out into the real economy. As you suspect it is just a roundabout way of subsidising the banks.

          [2], [3] and [4] are more straightforward ways for the government to spend. By choosing how to spend it can influence which parts of the economy improve. Unfortunately, current dogma requires all such spending to be matched with borrowing (or taxes). This largely neutralises the effect of the spending and gives the banks another subsidy.

          I believe the states do get some money from the federal government which covers [3].

          Pensions, social security etc. would count as [4].

          For the last few decades the preferred approach to get money into the economy has been to encourage an increase in private debt. This is wrong-headed for a number of reasons but it is very lucrative for the banks. Until they crash. Which is another opportunity for a subsidy.

          The last way to increase the flow of money into the economy is for it to export more than it imports. This is difficult for the US to do as everyone else wants its money so they can buy oil. There’s probably not much in it for the banks, either.

          1. Grumpy Engineer

            Aye, that’s true. The states and (occasionally) local governments do get some money with the federal government, but it’s always with strings attached. It’s only approach [3] in part. They have to spend it on certain things in a certain time period, even if they have greater needs elsewhere. And I’d rather see more go to the local governments, as they’re the ones mostly closely attuned to what citizens actually need. In my experience, they spend money more wisely.

            And pensions and SS are only approach [4] in part. A well-funded retirement system for retirees is of little use to underemployed college graduates drowning in student debt or other working stiffs struggling to get by.

            This is why I prefer approach [4], except for everybody. Right now we give “first spending rights” on newly printed dollars to (predominantly) the federal government and large corporations, and hope that it somehow trickles down to the rest of us. Or at least hope that it’s spent in a way that’s beneficial to us. Too often for too many people, it hasn’t worked out that way.

            If the economy is struggling because individual have too few dollars in their hands, then issuing new dollars to individuals seems like the most direct approach to me. Your comment about “encouraging an increase in private debt” is right on target.

        2. bdy

          Option 2 could be amended, from “Engage in deficit spending to force money into the economy,” to “Engage in deficit spending to employ ourselves providing things we need.” The real outcomes of spending and work are far more vital (or wasteful) than what spending looks like on the balance sheet. Guns or butter?

          1. Grumpy Engineer

            You said, “The real outcomes of spending and work are far more vital (or wasteful) than what spending looks like on the balance sheet.

            I agree wholeheartedly.

            This is what frustrates me so greatly about many of the calls for increased deficit spending. The ones where it doesn’t matter where money is forced into the economy. Paul Krugman infamously did this back in 2011, where he called for a fake alien invasion to drive a bunch of deficit spending (presumably on weapons to fight off the aliens) as fiscal stimulus. GDP would surely grow.


            And indeed, GDP would grow. Except that a massive chunk of that number would be for weapons that nobody ever used. And the goods and services that people actually need for their daily lives would likely end up thinner as a result. What a waste.

            That’s why I prefer option [4]. A jobs-based option [2] has some appeal, but I fear that it would be hamstrung by the usual Washington dysfunction and would have lots of people working on useless (or even wasteful) stuff. If the money comes from people who are given new funds for the purpose of meeting their own needs, any new economic activity that resulted would essentially have to be people-oriented.

            1. Ptolemy Philopater

              All these solutions that rely on the “invisible hand” of the market are doomed to failure. Giving money to people to buy goods from China does not increase the velocity of money in our economy. Likewise giving money to municipalities who use it to increase salaries doesn’t do that much good.

              The issue that everyone keeps avoiding is industrial policy, namely the visible hand of the government in the economy ensuring that the money goes to providing goods and services produced locally, creating both income and jobs. There is no substitute for a planned economy by a democratically accountable government, all the hand wringing and propaganda to the contrary, witness China.

              Oh no, but isn’t that communism! With modern communications technology there is no longer a need for the bottlenecks that stunted the Soviet bureaucratic authoritarian model. There are alternatives. But there is no alternative to rational planning as opposed to irrational rent seeking and hoarding.

              Likewise giving seniors enough money to hire youth to make up for the diminished agency of old age, does increase velocity.

              All the free market cobblers are not about increasing production but about increasing opportunities for corruption, witness our wonderfully free (corrupt) enterprise economy. Not that corruption is not a problem in any system. It’s just much harder to root out, when that corruption is legalized as in our present system.

              Finally, remove all the taxes plaguing labor. Social insurance should be paid from general revenues making it that much easier to hire people across the board.

              All this can be done with debt free money (MMT) taxes only needed to curb the excesses of the moneyed classes. All the beggar thy neighbor policies proposed by the oligarchy are as our beloved President Donald “Little Hands” Trump says, “Mean.” So what if a few idiots get away with something. Who cares? As Karl Marx’s son in law, Paul Lafargue, said in his famous book “The Right to be Lazy”, lazy people have rights too.

              1. JTFaraday

                “Likewise giving seniors enough money to hire youth to make up for the diminished agency of old age, does increase velocity.”

                Nah, I think we’ve had enough Uber and Task Rabbit.

        3. John Zelnicker

          @Grumpy Engineer – Your 4 paths of injecting new money into the economy are still government outlays. As long as these outlays are greater than the amount collected in taxes, etc., they are a form of deficit spending.

          Lower interest rates aren’t helping the economy because businesses won’t borrow unless they see enough demand to justify expanding production, no matter how low rates go.

          The ARRA underperformed for 2 basic reasons. One, it wasn’t nearly big enough and should have been 3 to 4 times larger. Second, it was poorly targeted, with far too much going to the wealthy in the first step or two so that little of it got to the people, as you noted.

          A rational fiscal policy would have the government spend as much as was needed to bring the economy to full employment, allowing the deficit to be whatever it turns out to be rather than trying to target a specific deficit number. All of your methods except the first would be useful for this purpose as long as the spending is targeted where it will help the vast majority of people and not just the wealthy.

          1. JTFaraday

            I think his point is that he is tired of vague deficit boosterism. Where is the industrial plan? What are the parameters of a 21st century welfare** state? etc.

            As usual, no input is forthcoming. The most substantive comments were his own. In light of this, one can hardly blame him for his skepticism.

            **And don’t tell me social security because much of a whole generation is being hindered in its ability to earn said benefits as we speak, (with more or less nothing to say).

            1. John Zelnicker

              @JTFaraday – If that is his point, that’s good. Vague boosterism doesn’t really help anyone. As with most things context is all-important, as is nuance, due to complexity. We do need a much better set of plans and comprehensive strategies.

              I wouldn’t bring up Social Security as an answer. The “gig economy” is a very poor way to accumulate SocSec benefit credits. It also requires the worker to pay the full amount of his contributions since most gigs pay people as independent contractors with no employer contribution.

    3. TK421

      Oh, wow, in that case he should have included “often” in his statement, for instance “A deficit is often necessary for a reasonable level of economic activity.”

  4. Susan the other

    Since Maggie and Ronnie and Tina, the whole public spending to create a healthy basis for an economy flew out the window. That’s 40 years of devastation and requires at least 40 years of catch up. When you let your society, your civilization, go to hell in a hand basket it’s a lot more expensive to get back to where you should have been after those dreadful 40 years in the wilderness. I liked these quotes from above: ” … apart from noting that there is a wide range of ways of measuring public debt and which liabilities are included, the is no recognition that government has substantial infrastructure and other assets, which have often been funded by borrowing.” And even more rational – that money doesn’t have to be “borrowed” at all because it goes on the social balance sheet. And then this rhetorical question, “What evidence is there that a balanced structural budget is feasible – that it is possible to achieve a budget in balance?” apparently none.

  5. Joel S.

    Professor Arestis, Reinhart and Rogoff were wrong about the UK and the US, for the same reason that deficit scare-mongers are wrong about these two countries: the US and UK governments issue their own currency! The size of the debt has no bearing on the ability of a sovereign government to purchase items for sale in its own currency. Why do you not acknowledge this fundamental fact?

    Countries like Greece, Portugal, Ireland and other Eurozone countries surrendered their sovereignty and currency-issuing authority to the ECB, and so their bonds carry a default risk. For the US and UK, as long as the government chooses, their treasuries will always pay its debts.

  6. Chauncey Gardiner

    Thanks for this post. After what we’ve seen and at the risk of being overly simplistic regarding federal fiscal spending, one begins to consider the possibility that recessions might be intentionally engineered and protracted. Core CPI is now reportedly in deflation.

  7. Jim Haygood

    “The question should always be whether the fiscal position is supportive of a high level of economic activity, and the budget deficit should be large enough to support that level of economic activity.

    This is junkie logic — “whether my daily heroin intake is supportive of a high level of economic activity.” Hey, it worked for Keith Richards (until he realized his own self-delusion and kicked the habit).

    From 1790 to 1930, the US grew like a weed with federal spending at around 3% of GDP. That’s TOTAL spending, mind you — the deficit (if any) was a fraction of a percent of GDP. Chart:

    Countries living on constant fiscal stimulus are nation-state tweakers. Got meth?

    1. Ed Seedhouse

      You are merely using emotionally loaded language to dispute well established facts. The facts remain the facts.

      The only source of money for the private sector is government debt. Either current debt or past debt. Without deficits there would be no money for you and I to spend. These are facts. All your emotionally loaded ranting won’t change that.

    2. Grebo

      “whether my daily food intake is supportive of a high level of physical activity.”

      Time for my dinner.

  8. Here's To Hope

    The issues are simple at their core. There is not a lack of money in the developed world, there is a lack of the courage it would take to rebalance how it is used and who is dominant in acquiring it.

    A decision to run countries in the greater interest of its human citizens first, as the fundamental basis of all decisions would sort it out. Make the correct decision to start out, everything else will follow from that. No need to try to decipher a world economy so fluid that almost nobody can understand it.

    I don’t refer to any economic or political agenda. For example in terms of trade deals and promoting economic activity, the caveat would be that such deals cannot impinge upon hard won national sovereignty (the ability of the elected government to solely make decisions in the interest of it’s human citizens) which cedes decision making power to other nations or non-human entities, which is where the problem we see began and lays.

    This is not what Trump is blathering about of course, in case it seems I’m spinning that economics incompetent line.

    In terms of government deficits, the answer is to keep a spending policy that follows the population instead of increasing expenditures when there are surpluses. A more flat spending curve would allow debts to be paid when times are good to balance when deficits are needed for stimulus.

    Without a truly massive shock I am not hopeful that it could actually happen.

  9. Billikin

    Grumpy Engineer:

    “Also, it looks like these equations would only be valid for a fixed number of dollars”

    If you mean the sectoral balances equations, they concern flows, the circulation of dollars (or whatever money), not any number of dollars, fixed or otherwise. They hold for any duration of time.

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