In March 2009, it looked really dark for the world economy. Everything pointed downwards. Since then, stock markets around the world have risen significantly, and the fall in world trade has stopped. It may also seem as if unemployment and surrounding housing markets may have stabilized.
Is the financial crisis over?
If it is – is it because politics in different countries has worked?
Are reforms being implemented that are working?
Or have we just had a short break before it breaks loose again?
If we are to be able to prevent new financial crises, it is wise to try to understand what happened when it collapsed in earnest in the autumn of 2008. Then the investment bank Lehman Brothers went bankrupt, and the world’s financial markets stopped completely. For a while, it seemed as if all lending, all financing and thus all trading outside of that which is based on cash payment and barter, could collapse. Today – a year and a half after the world economy had a “heart attack” – there is quite a lot of agreement on many of the factors that must be included in a sensible explanation of why we had a financial crisis.
Several of the factors can also be seen as political problems that can at least in principle be solved. Other, more underlying, issues are more difficult to deal with politically. Finally, we can single out acute crisis measures that proved surprisingly easy to get started. The rest of the article is arranged around this threefold division, and we begin with the end.
2: Why are urgent crisis measures needed?
An old saying goes that banks are institutions that rent out umbrellas in the sunshine and demand to get them back when it starts to rain. This is a little unfair, but only a little. It is a reality that banks and other institutions that lend money behave co-cyclically . Banks tend to be generous in upturns and cautious in downturns. In this way, banks and other lenders quickly reinforce the trend that may prevail in an economy at any given time.
No wonder it’s like that. In times of upturn , demand is high, and it is therefore easier to make money. When it is easier to make money, it seems safer to lend money to those who want to borrow to try to make money. We find a similar effect in the housing market. In times of upturn, house prices rise. If the value of the mortgage (most often the home) increases, it seems safer to lend more money.
In times of recession , the effect is the opposite. Falling house prices and demand make it more risky to lend a lot of money. If the bank also starts to lose on business customers and home buyers, it must at least lend less. It must do this in order to maintain its equity ratio (how much money the owners are responsible for in relation to how much the bank has borrowed – for example from deposit customers). The authorities require banks to have a certain share of equity. It should act as a buffer against losses and make the individual bank more stable. This means that when the bank loses money, it loses equity and the share of equity is to be maintained, it is often easiest to slim down the entire business a little.
3: Short-term measures: Which crisis package?
Against this backdrop, we better understand what needs to be done when a financial crisis hits an economy.
Then the demand that disappears when the banks and the private sector tightens must at least be partially replaced. This is most easily done by the public sector starting to spend more money.
In addition, people and businesses can be given more money in their hands. This is most easily done by tax cuts and interest rate cuts.
Both public spending and tax cuts affect the state budget. When we change the central government budget’s balance between revenues and expenditures to influence demand in the economy, it is the use of fiscal policy instruments .
When the crisis is at its worst, however, there are some people and companies who do not want to spend money even if they get more in their hands in the form of tax breaks and lower interest rates. They have been intimidated, worried about the future and would rather pay off debt – or save in other ways – than spend money. The more such a fearful or panicked situation takes hold, the more important it becomes to spend money over the state budget rather than giving tax breaks. Tax breaks do not affect consumption if people are terrified and choose to save the entire gain.
Different countries have chosen different combinations of increased public spending, tax cuts and interest rate cuts for their crisis packages. According to PETWITHSUPPLIES, the United States has gone further than the EU. As we see from figures from the OECD (Figure 1), government deficits increased dramatically throughout the OECD area in the wake of the crisis. This is primarily due to three factors:
Special incentive programs where states spent more money to replace private demand
So-called “automatic stabilizers”, ie money that is paid out “automatically” because the economy is in decline. The best example is unemployment benefits.
Loss of tax revenue because the private sector earns (gives less income tax) and spends (gives less VAT) less money.
