But there is a much deeper disease rotting modern neoliberal capitalism. Many countries are stricken with debt deflation, caused by excessive private debt and the collapse of asset bubbles in real estate from 2007–2009, which led to severe recessions in many nations (or, in other words, “balance sheet recessions”).
The theory required to explain what is afflicting Western economies is Hyman Minsky’s financial instability hypothesis.
Keynesian stimulus was adopted by many countries from 2008–2010 which prevented depression, along with a poorly-designed and crony capitalist bailout of the financial sector in the UK and the US (which should have been more like a Swedish-style bailout of the early 1990s). Over the past year, there has been a marked turn to austerity and attempts to balance state budgets in many nations.
Two historical examples spring to mind that teach us precisely what happens in these debt deflationary circumstances:
(1) Under Roosevelt, the US had a recovery and falling unemployment in every year of Roosevelt’s administration from 1933 until 1937, but in the latter year Roosevelt listened to the advocates of austerity and tried budget balancing: the effect was to plunge the economy back into recession in 1937.While we have avoided the worst effects of debt deflation so far, we may see disaster in the coming years, as economies plunge back into outright recession.
(2) In the 1990s, Japan experienced its own debt deflationary crisis in the lost decade, which had been caused by a collapsing asset bubble in real estate. In 1996–1997, the Japanese Prime Minister Ryutaro Hashimoto turned to contractionary fiscal policy and austerity, including personal income and national sales tax increases. This plunged Japan back into recession and the lost decade persisted until the early 2000s.
The Taiwanese heterodox economist Richard C. Koo explains the nature of the crisis below, and how the West is making the same mistakes as Japan. Richard Koo’s notion of the “balance sheet recession,” I might add, owes a great deal to Hyman Minsky, an unsung Keynesian hero, a man whose theories ought to be read by policy-makers everywhere today.