How to Solve the European Economic Crisis: Challenging Orthodoxy and Creating New Policy Paradigms

Orthodoxies asserting that central bank functional ‘independence’ is necessary, and that maintaining an independent money issuing authority is always desirable, are simply not valid in all circumstances including, in particular, that of a debt/depression scenario. Budget deficits do not increase public debt. Rather, it is the new bond financing of budget deficits that increases public debt. In debt stressed conditions, interest rates rise as well as risk premia increase. Bond financing of large budget deficits was the method adopted around the world as a reaction to the global financial crisis. That approach contributed substantially to the upward spiral of public debt. This debt spiral could have been largely avoided by financing those budget deficits via new money creation rather than via new bond financing. Consequently, new bond financing is not the only way, or the best way, to finance on-going budget deficits in debt-ridden countries.

‘Fiscal austerity,’ which is now coming under increasing challenge, is an established ‘orthodoxy’ in Germany and some other European countries, whereas it is considered an unproven ‘paradigm’ in many other countries. Austerity policies — by lowering tax revenues without cutting tax rates — create ‘unhealthy’ budget deficits: and, when austerity-based deficit reductions are achieved by actually raising tax rates the problems contributing to demand contractions are compounded. The view, recently expressed, that abandoning fiscal austerity is now impossible is simply irrational, and wrong.

The orthodoxy that asserts that austerity and massive unemployment can be relied upon, and are the desired means, to reduce real wages and prices to improve profitability and competitiveness is misconceived (see later) in countries suffering high debt, deficient demand, downward wage rigidity, and already high unemployment.

With the above mentioned orthodoxies of questionable value and under challenge, a new macroeconomic policy strategy — involving new paradigms — is urgently required to address the unfolding economic crisis, particularly as it is developing in Europe.

The above are excerpts from Richard Wood’s book “How to Solve the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms,” now available on Amazon.

3 Responses to “How to Solve the European Economic Crisis: Challenging Orthodoxy and Creating New Policy Paradigms”

benleetDecember 19th, 2012 at 2:45 pm

Abba Lerner explicated Functional Finance in the 1940s, proposing the same marriage of fiscal and monetary policy to achieve full employment. Wikipedia has an article on Functional Finance.
". . . government shall maintain a reasonable level of demand at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too much spending, the government shall prevent inflation by reducing its own expenditures or by increasing taxes."
Most recently has run a series of interviews with an economist at the UN, part of UNCTAD, who proposes the same remedy. See interview:…
This joining of fiscal and monetary is heresy, of course. Full employment and rising wages is also heresy, so is shared prosperity. Economic democracy is just peeking its head over the horizon. 84% of all assets are owned by 10% of the planets adults according to Credit Suisse bank's World Wealth Report.

EugenRDecember 19th, 2012 at 4:53 pm

Since 2008 economic crisis, the public debate about government finances is concentrated on the issue of the public and particularly government deficit. Yet the issue is not the government deficit itself. After all the government could decide to buy back all its debts by printing more Money, and if it would cause pressures to general price increase, it could increase the minimum reserve rate requirement and keep stable by it the volume of Money in the economy. By doing so it would reduce the commercial banks role, and increase in parallel the government's role as finance and resource allocator.
The main problem is not how the government deficit is financed, but who is in charge of the monetary side of the economy. So the government deficit is not financial but rather political question.

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Richard Wood Richard Wood

Richard has published papers on wages policy, the taxation of financial arrangements and macroeconomic issues in Pacific island countries. Views expressed in these articles are his own and may not be shared by his employing agency. He is the author of How to Solve the European Economic Crisis: Challenging orthodoxy and creating new policy paradigms