We Need A Plan B To Curb The Debt Headwinds |
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March 3, 2010
Policymakers have responded to successive economic downturns in essentially the same Keynesian way since the 1950s. Fiscal deficits have been allowed to rise and interest rates to fall to stimulate aggregate demand.
Policymakers have responded to successive economic downturns in essentially the same Keynesian way since the 1950s. Fiscal deficits have been allowed to rise and interest rates to fall to stimulate aggregate demand.
Though Keynes hardly anticipated such repeated use of macro instruments, these policies have worked. As a result, the policy response to the current crisis has been "more of the same". Many policymakers remain confident that this will eventually generate a sustained recovery. Yet it is worth reflecting on why it might not work this time, and what other public policies might help foster recovery. In short, what is Plan B?
An unsustainable level of private sector debt is the main factor explaining the present severe downturn, as well as many previous downturns in history. Today, the problem principally resides in the household sector in many advanced market economies. In Japan in the 1980s, corporations went on a similar spree of spending which was almost wholly funded by debt. However, the problem with debt is that it constitutes a claim on future earnings, which cannot be met if earnings expectations fail to materialise.
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