Has the European case formed the wrong impression?

At the beginning of the recent crisis, a loose monetary and fiscal policy was advised and implemented in almost every Western country in a bid to boost total demand and prevent further job losses.

However, when it was understood that there were also very serious deficit and debt problems in some European countries, economic policy advisers were divided into two different groups. On the European side, a large number of economists and governments in leading economies began to defend measures (that is, tight monetary and fiscal policies) in order to first off solve deficit and debt problems. On the other side of the Atlantic, both the American administration and the monetary authorities thought it was too early to take steps to deal with deficit and debt problems before any hopefully upward movement in total demand and employment was observed.

Business circles were likewise divided into two different groups. One group has supported the European side on the grounds that it was irrational to continue to implement loose monetary and fiscal policies before reaching reasonable deficit and debt levels. They also said that if the FED continued to implement a loose monetary policy and if the U.S. administration supported such a move by implementing a loose fiscal policy, another financial crisis, or so-called “second dip” could become inevitable.

The other group believed that the untimely implementation of tight monetary and fiscal policies to reduce the volume of deficits and debts would harm any development in total demand, production and employment and would delay the end of the crisis or, more seriously, might push the leading economies into the “second dip.”

These two views, which are quite different from each other, still have their advocates. Listening to these two different views, it is really difficult to decide which one is more feasible or which one is more harmful. But waiting to see the results of these two different policy packages in order to reach a proper decision is nonsense. The austerity measures implemented in Europe have yet to give any hints that they can solve the debt and deficit problems within a reasonable period of time, while the stimulus packages that have come one after another in the United States have yet to sufficiently revive total demand and employment.

Some prominent Keynesian economists in the U.S., say the fear of deficit and debt problems and austerity measures implemented almost all over Europe has created a bad example and made U.S. authorities overly cautious about preventing the implementation of comprehensive stimulus policies. They might be right. A few days ago, some important policymakers in the FED expressed their concerns about the probable outcome of the bank’s easy monetary policy; they meant, of course, the threat of inflation.

This threat cannot be ignored if all the stimulus efforts designed to increase total demand cannot increase production and employment at the same pace. Will it be a repetition of 1970s-style “stagflation?” Although it seems that the possibility of another bout of stagflation is quite low after so many years and after policymakers gained so much experience, it is still a risk, big or small. Authorities and some economists think that the increase in total demand is already so weak that it can no longer stimulate production and employment.

Another important question is why total demand is so feeble in spite of all the stimulus packages? The obvious answer is that people are still very cautious, preferring to spend less and save more. It is very difficult to change that behavior by resorting to official, optimistic projections for the near future. Elderly people who have unpleasant memories will especially stay thrifty for a time, while younger people who can’t find proper jobs for perhaps the first time in their lives will following in their parents’ footsteps.
Ultimately, there’s the same old question: Did Europe really create a wrong impression for some Americans who advocate tight monetary and fiscal policies in spite of the still stagnant economy, or is their risk perception totally different from Europeans’ views? It seems that the answer for the second part of that question is positive. While the majority of European governments are concerned with deficit and debt problems, American authorities are still afraid of a new surge in inflation. It is better to figure out which side is right as soon as possible.