Is the Next Economic Crisis Impossible to Prevent?

Financial analysts are still debating whether the world economy requires another substantial dose of fiscal stimuli; considering that the global unemployment rate has soared and that the future looks grim as well.

In the U.S., the crisis was so severe that it was necessary to adopt the emergency measure of a stimulus package that pumped $787 billion into the economy in February. At that point, it would have been feasible to have an even larger stimulus package. However, according to Bruce Bartlett’s recent Forbes magazine article, all similar measures would be extremely risky now.

The economy was only able to recover from the Great Depression through the massive spending of World War II. But, people drew the wrong conclusion from this piece of history. They started to think that fiscal stimuli are the answer for any economic downturn.

Just like in the 1970’s, the result could eventually be stagflation. History will repeat itself unless people have some forethought and avoid the overuse of such fiscal policies, as these measures can only be justified under extreme circumstances.

After the Great Depression, economists understandably tried to do all they could to prevent similar disasters from reoccurring, especially because some theories at that time stated the crisis would shortly return after the initial recovery.

In the U.S., Congress ensured the stability of workplaces through the Employment Act of 1946. Thus, the U.S. government took all measures necessary in order to provide jobs for every American citizen and avoid another depression.

Although there were no precise “instructions,” John Maynard Keynes laid out the general objectives of this theory. He said that when spending by the populace decreases dramatically during a recession, public spending should increase in order to fill that gap and prevent, or at least moderate, a possible new crisis.

In an essay published in 1951, the economist Milton Friedman cast doubt on Keynes’ theory, arguing that his suggestions could only function if the prognoses were exact and the stimuli were perfectly calculated and synchronized. If these conditions were not met, the stimuli would come either too late, or too early, and in the wrong dose, which would only deepen the crisis.

Therefore, instead of ending the recession, the stimuli would create a never-ending cycle of economic rise and fall.

Unfortunately, Friedman was right. Economists have rarely been able to foresee a recession early enough to prepare a fiscal stimulus program. Moreover, they have denied that problems existed, even when the effects of the crisis on the economy were already visible.

And when the signs of the recession were identified, the economists’ delayed reactions meant it was impossible to put any rehabilitation plan into practice. Even after they managed to act, the government would take too long in preparing the legislation necessary before implementing any measures.

This is the vicious cycle that will continue without end, no matter how many recessions we face and how many crises threaten us with bankruptcy.