Milorad Katnić, PhD.
Fiscal Policy (Mis)use in times of the crises
Novija istorija predstavlja odličnu laboratoriju za izučavanje ekonomskih
međuzavisnosti, uzroka i posljedica. Zato ovaj rad započinje osvrtom na Veliku
ekonomsku krizu (VEK), institucionalni ambijenti koji joj je prethodio,
razmatranjima o aktuelnoj svjetskoj ekonomskoj krizi (SEK), kao i zajedničkim
uzrocima, lijekovima i posljedicama ove dvije po obimu najznačajnije krize koje je
novija istorija upamtila. Komparativni pristup i relevantna empirijska istraživanja
mogu mnogo pomoći u boljem razumijevanju ovog procesa. Stoga su
predstavljeni rezultati referentnih istraživanja o posljedicama finansijskih kriza.
Fokus rada je na (zlo)upotrebi fiskalnih instrumenata, u uslovima krize. Krize se
koriste kao opravdanja i povodi za povećanje državne potrošnje. Tako je bilo
tokom i nakon VEK iz prošlog vijeka, tako je i danas, tokom suočavanja sa SEK.
Jednom povećanu državnu potrošnju teško je kasnije korigovati unatrag. Ovo je
vrlo rijetka pojava u istoriji. Sve i kada bi se povećana potrošnja mogla za kratko
vrijeme vratiti u pređašnje granice ovaj proces ostavlja teške posljedice, među
kojima je najvidljiviji, ali ne i najbolniji, teret državnog duga za buduće generacije.
Iako malo ko osporava nedjelotvornost kenzijanskog odgovora na krizu iz XX
vijeka, a pronicljivi istraživači u posljedicama ove politike pronalaze uzroke
današnje krize, slični recepti se nude kao spasonosni. Tržište se dominantno
predstavlja kao nepopravljivo zlo, vođeno pohlepom i zanosom nekontrolisanih i
neregulisanih špekulanata i jedino je država ta koja može i treba spasiti sirote
žrtve - građane (glasače). Vođeni pritiskom od strane stručne i laičke javnosti da
se država uhvati u koštac sa ekonomskom krizom, da učini nešto, bilo što samo
da ne „sjedi skrštenih ruku“, donosioci odluka se utrkuju u obuhvatnosti i
obimnosti fiskalnog stimulansa.
Ključne riječi: Velika ekonomska kriza, Svjetska ekonomska kriza, diskreciona
The recent history represents a marvelous laboratory for studying the economic
interdependence, causes and results. In the light of the above, this paper starts
by reminding of the Great Depression (GD), the institutional environment
preceding it, review on the current World Economic Crisis (WEC), as well as the
common causes, cures and consequences of these two most important crises of
the recent history. The comparative approach and relevant empirical research
can be of great assistance in better understanding of this process. Therefore, the
paper provides for the results of relevant researches on the consequences of the
The paper is focused on (mis)use of fiscal instruments in the conditions of the
crisis. Crises are used as for justifying and surge in increase in public spending.
The same situation happened during and after the Great Depression from the
past century, as it is nowadays while facing the World Economic Crises (WEC).
Once increased, the public spending is difficult to alter in opposite direction. This
occurs really in the history. Even if the increased spending would return into the
state it was before, this process would leave major consequences, among which
the most visible, but not the most painful one is the public debt burden imposed
to future generations.
Although there are few arguing the inefficiency of Keynesian answer to the crises
from XX century, and researchers are finding in the consequences of that crisis
reason of current crisis, similar solutions are often given. Market is mostly
presented as unfixable evil, driven by greed and activities of uncontrolled and
unregulated speculates and the state is only one which can and should save
poor victims- citizens (voters). Driven by the pressure of public that the state
should solve economic crisis, to do something and not just to stand, the decision
makers are competing by size and extent of fiscal stimulants.
Key words: Great Depression, World Economic Crises, Discretion Fiscal Policy
Новейшая история представляет собой прекрасную лабораторию для изучения
экономической взаимозависимости, её причин и последствий. В соответствии с этим, в
начале данной работы уделяется внимание экономическому кризису, учитывая
институциональные условия, которые предшествовали кризису, замечания по вопросу
нынешнего мирового экономического кризиса, а также общие причины, средства защиты и
последствия, с точки зрения два серьезных кризисов, которые новая история запомнила.
Сравнительный подход, а также и соответствующие эмпирические исследования, могут
помочь лучше понять этот процесс. Таким образом, представлены результаты
исследования по изучению последствий финансового кризиса.
В центре внимания данной работы приведены налоговые инструменты, которые
злоупотребены в период кризиса. Кризисы использованы в качестве оправдания
или предлога для увеличения государственных расходов. Это было во время и
после великого экономического кризиса прошлого века, и сегодня, во время
мирового экономического кризиса. Раз увеличенные государственные расходы
трудно настроить позже. Это очень редкое явление в истории. И в случае, когда
увеличенные расходы можно вернуть в предыдущие пределы в течение короткого
времени, чтобы ограничить этот процесс, это оставляет серьезные последствия.
Из этих последствий выделяется, больше всех, бремя государственного долга для
Хотя лишь немногие оспаривают неэффективность «кензийского» (вмешательство
и влияние государства на экономию) ответа на кризис в двадцатом веке,
проницательные исследователи ищут причины в плане определения последствий
такой политики. Чтобы найти причины нынешнего кризиса, подобные рецепты
предлагаются в качестве спасительных. Рынки в основном представлены как
непоправимое зло, и только государство может и должно сохранить бедных жертв
- граждан (избирателей) от жадности неконтролируемых и нерегулируемых
спекулянтов. Под давлением специалистов и широкой общественности в борьбе
государства с экономическим кризисом, чтобы сделать хоть что-нибудь, и чтобы не
«сидеть сложа руки», лица, принимающие решения, участвуют в гонке за
увеличение объема налоговых стимулов.
Neuere Geschichte stellt ein ausgezeichnetes Labor zur Erforschung von
wirtschaftlichen Zusammenhängen, Ursachen und Folgen dar.
Diese Arbeit beginnt daher mit Rückblick auf Große Wirtschaftskrise (GWK), das
ihr vorangegangene institutionelle Umfeld, mit Erörterung der aktuellen
Weltwirtschaftskrise (WWK), sowie auf gemenisame Ursachen, Heilmittel und
Folgen dieser zwei, nach dem Ausmaß, bedeutesten Krisen, die neue
Geschichte vezeichnet. Ein komparativer Zugang und relevante
erfahrungsgemäße Forschungen können viel einem besseren Verständnis
dieses Prozesses beitragen. Deswegen wurden die Ergebnisse der
bezugsmäßigen Erfoschungen der Folgen von Finanzkrisen dargestellt.
Fokus der Arbeit beruht auf (Miß)-Brauch von steuerlichen Instrumenten bei
Krisenumständen. Die Krisen werden als Rechtfertigungen und Anläße zum
Anstieg des staatlichen Verbrauchs benutzt. So war es während und nach dem
GWK aus dem letzten Jahrhundert, und so ist es auch heute im Rahmen der
Konfrontierung mit WWK. Einmal erhöhter staatlicher Verbrauch lässt sich
später schwer rückkorrigieren. Dies ist eine sehr seltene Erscheinung in der
Geschichte. Und wenn es sogar möglich wäre, den erhöhten Verbrauch
innerhalb einer kürzer Zeit in frühere Grenzen zurückzubringen, hinterlässt
dieser Prozess schwere Folgen, unter denen die erkennbarsten, doch nicht die
schmerzhaftesten, die Last der Staatschulden für künftige Generationen ist.
Obwohl kaum jemand die Unwirksamkeit der keynesianischen Antwort auf die
Krise aus dem XX.Jahrhundert bestreitet, und die scharfsinnigen Erfinder finden
in Folgen dieser Politik die Ursachen derzeitiger Krise, ähnliche Rezepte werden
als heilsam angeboten. Der Markt wird hauptsählich als eine unverbesserliche
Übel dargestellt, der von Habgier und Begeisterung der unkontrollierten und
ungeregelten Spekulanten geleitet wird, und allein der Staat ist derjenige, der
arme Opfer – Bürger (Stimmabgeber) retten und sollen kann. Geleitet vom Druck
seitens der Fach- und Laienöffentlichkeit, daß der Staat mit der Krise
zurechtkommen, irgendwas tun sollte, um nicht nur mit den „gekreuzten Händen
zu sitzen“, rennen sich die Entscheidungsträger in Umfaßlichkeit und
Umfänglichkeit der steuerlichen Förderung.
Schlüßelworte: Große Wirtschaftskrise; Weltwirtschaftskrise; diskrete
Great Depression (GD)
Bernanke1, the Head of the U.S. Federal Reserve, is the author of the Essay on
the Great Depression, presenting his and other conclusions and perceptions on
the Great Depression. Bernanke is stating that proofs are indicating that the
“Severe Contraction” – world’s shrink in aggregate demand in 1930, was, to the
greatest extent generated by the monetary shocks2, spreading worldwide,
primarily through the gold standard3.. According to Bernanke, there is a widely
accepted opinion that the U.S. Federal Reserve policy in 1928 was contra-cyclic
(restrictive), intended to correct capital markets speculations. The narrowing of
the monetary base, with simultaneous increase in the gold inflow in the period
June 1928 – July 1930, has led to a significant decrease in the money-gold ratio.
The fall of the Kreditanstalt, the biggest Austrian Bank in May 1931, has triggered
the banking panic and foreign currency crises. This generated the decline in the
aforementioned money – gold ratio, i.e. significant decline in cash in circulation,
subsequently causing the decline in property prices (shares, real estate, etc.).
The general prices decline negatively affected the entire economy, especially the
banking sector. This fall led to the decrease in the value of the borrowers net
assets, subsequently decreasing the collateral. When the collateral is bellow the
debt value, the loan is exposed to the greater risk of timely servicing. Business
activities, once economically justified prior to the fall in general prices, are being
reexamined, creating the situation in which the borrowers are failing in servicing
loans from their regular business activity. The inability to service loans, along
1 Ben S. Bernanke, Essays on The Great Depression, Princeton University Press, 2000.
2 „New research on gold standard is allowing us to justifiably claim that monetary factors have played an
important causal role, both at the time of the world’s decrease in prices and production and its recovery ”-
B. Bernarke, page 7.
3 Suspended during the First World War, the gold standard was restored after the war: Great Britain
returned to the prewar gold standard in 1925, France fully returned in 1929, when the gold standard was
virtually universal among market economies. Return to the gold standard was emphasized and praised as
the main diplomatic achievement and an essential step towards the reestablishment of a stable monetary
and financial system, which featured the period of 1870-1913 (the classical gold standard period).
However, in 1931 it was clear that the desired financial stability failed to be achieved, but the world was
consumed by the financial panic, which was characterized by the exchange rate crises, thus most countries
have abandoned the gold standard.
with the inadequate collateral, is generating adverse effects to the bank’s capital.
Simultaneously, market disturbance causes the pressure on deposits withdrawal,
subsequently decreasing the credit base for new loans, decreasing the money
multiplier, and the cash in circulation thereon. The banking sector problems have
generated the weakening of the entire financial system, being less efficient.
Financial mediation expenses grew, and the quality of services fell, thus both the
individuals and companies were facing difficulties in obtaining expensive loans.
This generated the additional decrease in the crediting volume causing additional
decrease in the cash in circulation.
Simultaneously with deteriorated situation in the financial sector, especially the
banking one, the contraction has spread to the real sector. Financial sector
disturbance has increased the real creditor – borrower mediation costs. Not only
that the loans became unavailable, they became expensive. Projects which at
prosperous times could be smoothly financed, they become difficult to finance at
the time of the crises even at the higher price. It happens often that even good
projects fail to be financed. Thus the banking crises4 is more likely becoming the
economic system disorder.
To summarize, two factors have mostly affected the fall of the banking sector.
The first one was the increase in “bad loans”, i.e. increase in outstanding
liabilities to banks and deposits withdrawal5. The period that preceded the crises,
has recorder the sharp increase in debt at all levels – citizens, entrepreneurs,
large companies, municipalities and government.
Aforementioned three paragraphs are describing the U.S. banking and economic
system collapse eighty years ago, during the Great Depression. They could
literally relate to any economy affected by the current crises, including
Montenegro. One would say, that the history (cycles) is relentlessly repeating,
and others that the history has thought us nothing.
The Reminiscence of Previous Financial Crises
The recent experience is indicating that the main financial crises aftermaths are
the long – term negative consequences. By analyzing the biggest “modern“
financial shocks, Reinhart and Kenneth6 have found that the banking crises7 in
4 Percentage of banks that went bankrupt in the United States during the period 1930 – 1933, amounted to
5,6; 10,5; 7,8; and 12,9, respectively. Due to the collapse and merge, the number of banks in 1933, against
1929 was almost halved, and the remaining ones suffered huge losses. The bankruptcy wave reached its
peak at the fall of the banking system in March 1933.
5 B. Bernanke, page 44.
6 Carmen M. Reinhart and Kenneth S. Rogoff, “The Aftermath of Financial Crises”, December 19, 2008.
7 “Five great“ banking crises erupting after the Second World War were recorded in developed economies
and relate to the following ones: Spain 1977, .Norway 1987, Finland 1991, Sweden 1991 and Japan 1992.
the most important crises that hit the emerging markets relate to the following: Asian crises in the period of
1997–1998. (Hong Kong, Indonesia, Malaysia, Filipinas and Thailand), Columbia 1998 and Argentina
rich and emerging markets8 have surprisingly many similarities. They have a very
similar pattern in the trend of the real estate and shares prices, unemployment,
national income and state debt.
There are three negative commonly prevailing trends in both developed and
emerging economies. The first one is that the real estate prices are falling at the
average by 35% retaining at the low level for over six years, while the shares
prices are falling at the average by 55%, and negative trends last for about three
and a half years. The second one is that the consequences of the banking crises
are associated with a sharp decline in the overall economic activity and
employment. The unemployment is growing at the average by 7 percentage
points in the course of the negative phase of the cycle, which lasts for about four
years. Especially pronounced negative consequence relates to the decline in the
real gross domestic per capita, at the average by over 9%, for an average period
of two years. The third one is the explosion of the real value of public debt,
growing at the average by 86% in most of the crises that occurred after the
Second World War. The biggest part of this expense is not directly linked to the
rescue of troubled banks through nationalization and redemption of bad debts, or
assuming the payments of guaranteed deposits, it is more the result of a
prolonged recession and fiscal expansion, designed to counteract the crisis.
Primarily, the cause is an inevitable tax revenues collapse, being the result of a
deep and prolonged economic activity contraction and often ambitious contra-
cyclic public spending intended to soften the lending.9
The question is how, to what extent these data may be used as a benchmark for
the current banking and economic crises? The answer is difficult because even if
observed as the same process, all examples of analyzed crises were more
isolated ones while the current economic crises is rather a global one. In the light
of the above, the battle in counteracting it is more complicated and the crises is
leaving unpredictable consequences. Some countries after "only" few months of
facing the crisis are recording the most negative decline values of the real estate,
shares, GDP, employment and other indicators, and many are predicting that the
worst is yet to come. Thus the alarm and anxiety among citizens and decision
makers is not surprising, as well as the growing pressure to undertake actions to
stop the avalanche of negative trends.
The experience should teach us on how we should economically (not)react not
just to prevent the crises but to tackle it when it erupts. The current World
Economic Crises is implying that, regardless of the accumulated knowledge and
understanding, it is difficult to predict the economic cycles of the Great
Depression, being less predictable. Moreover, known and proven, as well as new
8 There isn’t a “commonly accepted“translation for the „emerging markets“. This term is usually translated
into our language as the rising economies or fast – growing economies. In this document both terms will be
used as synonyms.
9 Carmen M. Reinhart and Kenneth S. Rogoff, “The Aftermath of Financial Crises”, December 19, 2008.
creative measures to face with the crises are considered more harmful than
useful. The rest of the document is focused on these issues.
World Economic Crisis
The IMF’s World Economic Outlook from October 2008, starts with the following
statement: “The world economy is entering a major downturn in the face of the
most dangerous financial shock in mature financial markets since the 1930s”10.
After years of the strong GDP growth11, accelerated trading with goods, services
and technology, as well as the increase in investments volume globally, the world
economy is rapidly decelerating12.
Deceleration was preceded by great turbulence on the food and industrial
products market, especially fuels. As of 2004, the food and fuel prices have
exploded, reaching record levels in 200713. Nonetheless increase affected the
real estate and shares market. Decision – makers were worried and citizens
were frightened by the growing inflation. All attention was focused on its curbing.
The financial crisis erupted in August 2007, with the U.S. subprime mortgage
collapse. Up to September 2008, the global confidence in financial institutions
was completely ruined. The most dramatic downturn occurred in the banking
sector solvency generating the bankruptcy of then the biggest and most
prestigious banks, calling for the state interventions on the U.S. and Europe’s
financial markets. Liquidity decline, acquisition, nationalization and liquidation of
financial institutions have brought anxiety, fear and the lack of confidence in
liquid, solvent and healthy financial institutions. The general uncertainty, and care
for “tomorrow” and negative expectations, mixed with increasingly expensive and
unavailable money, generated a sharp decline in demand for consumer goods
causing inventories pilling up, decrease in prices, losses and bankruptcy of
companies in the real sector. The adaptation to the new conditions required the
decrese in production, dismissal of workers, lower investments which along with
10 World Economic Outlook - Financial Stress, Downturns, and Recoveries, International Monetary Fund,
October 2008, page. 1.
11 By summer 2007, the worlds GDP has accounted for the average growth rate of 5% four years
consecutively, which is the highest growth from 1970.
12 In the period from forth quarter 2007 – second quarter 2008, the recorded growth was only 1% in
developed economies in comparison with the growth of 2,5% in the first three quarters of 2007.
13 The sharp growth in food and oil prices has led to the comprehensive fiscal agreement answer in most
countries. The IMF’s study has included the "answer" in 161 countries. The analysis shows that more than
a quarter of countries have introduced subsidies investigated associated with an increase in fuel prices, a
fifth has reduced some taxes. In response to increasing food prices, more than half the countries have
introduced subsidies and about 1 / 5 has reduced taxes. The exporting country have used a combination of
fiscal and regulatory measures, which are reflected in the increase of export taxes, the introduction of
quotas for exports, and some have introduced a ban on exports of certain products. The total fiscal cost of
these measures was significant, and at the level of the world amounted to about 0.7% of GDP during 2007-
08. year. For a quarter of the countries of this cost was above 1% of GDP. More detailed look, World
Economic Outlook - Financial Stress, Downturns, and Recoveries, International Monetary Fund, October
2008, pp. 103 and 104.
the need for increased social expenditures, was leading to the lower budgetary
revenues and extremely negative governments fiscal balances.
For a long time, many believed that the financial crisis will have the "decoupling"
effect, and that the emerging markets whose financial institutions are not buying
"toxic" securities will not be significantly affected by the crisis. Today, it is clear
that these countries were the ones particularly affected by the crisis, including the
economic growth deceleration percentage, reduction in capital inflows14 and the
loss of jobs.
The crisis in the Central and Eastern Europe became the classic emerging
markets crises same as the one that erupted in Asia in 1997, and Argentina
2000. The crisis has paralyzed the previous credit boom and high private capital
inflow, weakening confidence, linked with the negative historical experience of
bank failures, leading to the sudden and panic withdrawal of deposits.
The collapse of raw materials prices for certain countries, for Ukraine meant
double digit GDP reduction. This in turn increased the value of risky investments
of Western European banking groups, deepening the problems of their balances,
exceeding the possibilities of national governments interventions. The European
politicians are not only faced with the problem of maintaining the liquidity and
rescuing economies, but also with the threat of a common currency - the Euro
and united Europe.
In few months, the crises of one small financial market segment originating in
one (most powerful) economy has spread out to all open economies and all
economic, social and political life segments.
The first reaction of the U.S. and Great Britain’s decision makers to the crises,
was to inject additional liquidity in financial markets15. The objective was to halt
the downturn of the large industrial institutions. The decline in reference interest
rates was followed by the approval of government’s large rescuing packages.
The Europe has reacted similarly, although the European Central Bank has for
long hesitated to decrease the interest rates, due to inflation fear16.
14 The World Bank has forecasted that the net private capital inflow towards the emerging markets in 2009,
will probably reach the half of the record of $1 trillion generated in 2007. The Institute of International
Finance has published a more pessimistic forecasts based on which the private capital flows in the
emerging markets in 2009will decline by triple compared to 2008, or by over 80% compared to the record
2007. The largest decline is attributed to the decline in net income based on bank loans. Therefore, it is
estimated that the European emerging market region being the most dependable on external banking
financing will be most affected. The biggest fall is attributed to the decline in net income on the basis of
bank loans. the escape of the private capital means that the emerging markets will face with the lack of
15 According to some analysts, the action of decision – makers was neither undertaken in a timely manner
nor well designed. As an example is cited the “switch in opinion” related to the use of financial rescuing
package to the U.S. economy in the amount of $700 billion – through the rescue fund by recapitalizing
banks to the purchase of bad assets, popularly called poison assets.
Emerging markets were generally under the impression that the crises is local
and individual, linked with bad investments in financial derivatives, and that their
economies will be immune to the crises, and up to the last quarter of 2008 they
were concerned with the inflation pressure. After it became clear to everyone that
the crises will be of global scale and that states which took part in the
international exchange of goods, services and capital will not be speared, it led to
more extensive coordination and comprehensive joint action. The six biggest
Central Banks have opted to decrease their official interest rates and to inject $4
trillion of direct financial aid and guarantees aimed at unfreezing the credit
market and money, as well as recapitalization of unhealthy financial institutions.
All governments actions have failed in assisting to the greater extent. Following
the initial encouragements17, the confidence in accelerated switch in trends and
the restoration of trust was soon rejected by the market. The real estate prices
and shares have continued to fall, stock exchange industrial products such as
aluminum, steel and oil have reached their lowest levels in the history, and the
global trade was sharply decelerated. The unemployment rose day by day, both
in developed and emerging markets, such as China and India. Developing
countries were especially hit by the halt in foreign investments, i.e. “escape
capital“ leading to huge exchange rates fluctuations and fiscal positions
Pessimistic forecast soon became too optimistic. The IMF’s world growth
forecasts for 2009, from November 2008, in the amount of 1.75% in January was
revised to 0,5%. In March 2009, the IMF has additionally revised the forecast and
announced that in 2009, for the first time after 60 years of growth the global
recession will be recorded ranging from -0.5 and -1%.
The IMF’s expects that the deficit in rich counties in 2009, will reach 7% of GDP
respectively, which is huge increase in comparison to 2% of GDP in 2007. Public
debt growth forecasts are even more pessimistic, forecasted above 15 -20% of
GDP by the end of 2009, compared to only two years before. For emerging
economies, indicators are also negative. It is expected that the emerging markets
from the budgetary surplus which they have generated in 2007 will switch to the
zone of the budgetary deficit at the average of 3% of GDP. To summarize, the
state debt at the global lever will record its fastest growth since the Second World
16 This hesitation is being justified by different goals of the Federal Reserves and the ECB. And while the
basic goal of the U.S. Federal Reserve is to accelerate the economic growth and to decrease unemployment,
the basic goal of the ECB is to control inflation.
17 British Prime Minster Gordon Braun, in mid October at the meeting with the Eurozone leader countries,
has argued that the model of massive pumping of the state money into the financial sector, aimed at saving
the banks from the collapse, is providing results. However, the forth quarter has brought more sap fall of
1,5% (previously in third quarter the recorded fall was 0,6%), thus the Great Britain was officially in
recession for the first time after 1991.
Bad financial indicators mean weak credit rating and expensive funding, creating
adverse budgetary effects. The price of collateral for state borrowing has
increased sharply in last months, which indicates that the investors are
concerned with the increased risk in the ability of governments in servicing.
Simultaneously, the spread18 between the countries is increasing, even within the
Eurozone. Spread in term of 10 years of the public debt of Greece, Ireland,
Portugal and Spain versus Germany have spread sharply. Thus, Greece as the
Eurozone member at the beginning of 2009, had to pay 5,6% for ten – years
debt, i.e. by 2,5% higher than Germany.
Fearing that the worst is still ahead, creative and imaginative (macro)economists
are formulating new measures and instruments to combat the crisis, and
politicians are often randomly accepting them in order to avoid the possibility of
being accused of not taking enough action. Since the biggest part of monetary
instruments is exhausted by the international institutions, it is required that the
governments undertake more coordinated and strict fiscal action. It is suggested
that the fiscal response must be "significant, strategic and sustainable"19. The
"New Deal" is being advocated without hesitations. Its sending the message that
in the absence of serious fiscal incentives, the crisis will last longer and the
recession will be more severe.
According to conservative proposal, the amount of the fiscal stimulus should
range between 1% and 3% of the world's GDP. The growing consensus is that
this incentive should be higher, especially in economies with extremely low levels
of consumer and business confidence. Governments are encouraged to increase
their spending at minimum by 30% in order to generate positive multiplicative
effects. The IMF and the UN are leaders in addressing these encouragements.
The IMF's President Dominique Strauss Kahn is warning: ”If there has ever been
a time in modern economic history when fiscal policy and a fiscal stimulus should
be used, it's now".
Governments are suggested to direct their spending to investments in
infrastructure, renewable energy and energy efficiency, in order to provide for the
interrelation with the anti global warming measures. With the objective of
minimizing the risk, primarily in the fiscal deficit and public debt, they are
proposing the adoption of a sustainable mid-term fiscal framework, that will
forecast future tax increase20.
Large fiscal rescuing packages are ready in many countries, starting from the EU
and U.S. In December 2008, the European Council of Ministers has adopted the
fiscal assistance package worth EUR 200 billion. The U.S. Congress on 11th
18 Loan or bonds spread is the difference between different investments in relation to their quality, or risks.
19 „Massive, globally coordinated fiscal stimulus is needed: going from the drawing board to swift action“,
UN-DESA Policy Brief No.11, United Nations Department of Economic and Social Affairs, January 2009.
20 See: „Massive, globally coordinated fiscal stimulus is needed: going from the drawing board to swift
action“, UN-DESA Policy Brief No.11, United Nations Department of Economic and Social Affairs,
January 2009 and “Fiscal Policy for the Crisis”, IMF Staff Position Note, December 29, 2008.
February 2009, after a huge debate and wrangling, has adopted a compromise
law on additional financial stimulus worth $ 789 billion21. Non – recurring increase
in public spending in the U.S. may be measured only with the one that was
generated during the Great Depression. While after the Second World War, the
U.S. Federal Government spent around 20% of GDP, in 2009 planned spending
is at 28% of GDP, and the budgetary deficit will reach unforeseen 12,7% of GDP,
i.e. approximate amount of collected revenues. This is the highest peacetime
deficit in recorded history of the U.S., exceeding the federal budget in 2000)22.
Is the discretion fiscal policy the answer to the economic crises?
There is a long lasting open debate on the fiscal policy role in the period of
excessive business cycles, especially during the fall in economic activity. The
consensus of opinion has not been reached as it is the case with the most other
(economic) issues. Interventionists are advocating that the fiscal policy, if wisely
carried out, may assist the economy, especially if the problems are associated to
the “market error”. They are advocating that the fiscal measures are becoming
extremely important when monetary mechanisms are exhausted. The state
interventionist opponents are advocating that the fiscal instruments, at its best,
are useless, and the intervention is deteriorating conditions, causing long - term
negative consequences. They are explaining that these measures, apart from
generating market distortion, are greatly failing to correspond to the needs (may
not be implemented in a timely manner to counteract or to mitigate the negative
trends, often having pro-cycling effects, affecting the market only when it
redirects - “reaches the bottom”). Furthermore, the fiscal instruments are usually
exposed to the influence of the interest groups, thus the additional budgetary
spending and the tax burden decrease often take the feature of lavishness.
21 Immediately upon adopting the new assistance package, the shares market Immediately after the adoption
of the new package to help the stock market plunged again as many interpreted as a lack of confidence in
the measures adopted.
22 In parallel with call for the fiscal action, protectionist demands are prevailing. The current British Prime
Minister, in his statement in 2007 "British jobs to the British" sent the burning fiery arrow. The British
politicians and regulators, "recommended" to the banks that have received a piece of the tax cake, not to
lend it outside the house. Aforementioned policy was implemented by other decision makers in developed
European countries, particularly France. By regulating and interpreting this policy, even the Switzerland
has opted for the domestic borrowing, all under the banner of protecting domestic industry and domestic
jobs. The bigger the spreading and growing of the crisis, the bigger is the protectionist fiery element,
requests and specific action. One million French workers marched on 29th January the streets of Paris
demanding the protection of jobs and salaries. The British workers in the Lindsey refinery owned by the
French Total strike because of the presence of Italian workers engaged in the extension of the refinery. The
Italian company that performed work on the reconstruction of the refinery, has transferred several hundred
of its workers in Italy. Panicked British workers, worried for their job or their higher labor cost, organized
the strike, after which the company Total has decided to employ British workers. The opposition leader in
Parliament strongly reacted to the Brown's statement that the obligations towards the EU partners must be
adhered to. The announcement from the U.S. added oil to the fire or to the so called economic patriotism,
that Obama's stimulus fiscal plan will be consumed in America, i.e. that is those funds will not be used for
purchasing materials for the public works planned by Obama’s administration. Many governments have
publicly or secretly „advised“ the banks to be „cautious“ in reference to the transfer of funds allocated by
the state to the branch offices in other countries. Financers are encouraged to support domestic companies,
companies to employ residents and citizens to buy local products..
“Keynesian” argue that the personal spending and investments are dependant on
current revenues, and the economic activity is significantly affected by the fiscal
policy. Simultaneously, the fiscal policy impact is much weaker in open
economies with free capital flows where the fiscal stimulus may “flow - out”. In
accordance with the crowding -out23 standards arguments, the vast number of
neoclassic theories is emphasizing the expectations role with regard to the future
taxation and projections of available income, explaining that the fiscal multiplier is
low because the individuals and the companies in considering their future, will
pass decisions pursuant to the current spending.
The World Economic Crisis has deepened the discussion on the fiscal policy
impact as a contra – cyclic measure. The basis of the modern literature is that
the fiscal policy can work in two ways24. One way is through automatic stabilizers,
which arise from parts of the fiscal system that naturally vary with changes in
economic activity—for example, as output falls, tax revenues also fall and
unemployment payments rise. Discretionary fiscal policy, on the other hand,
involves active changes in policies that relate to taxation, subsidies, transfers,
social contributions, etc. since the automatic stabilizers influence is limited, the
attention at the time of economic crises is focused on discretionary fiscal policy.
The IMF in its “Fiscal Policy for the Crisis”25 made the reference to the vast fiscal
response at the global level. According to the IMF, the optimal fiscal package
should be timely, because the need for action is immediate; large, because the
current and expected decrease in private demand is exceptionally large; lasting
because the downturn will last for some time; diversified because of the unusual
degree of uncertainty associated with any single measure; contingent, because
the need to reduce the perceived probability of another “Great Depression”
requires a commitment to do more, if needed; collective, since each country that
has fiscal space should contribute; and sustainable, so as not to lead to a debt
explosion and adverse reactions of financial markets.
The MMF is recommending that the least what the governments can do is not to
delay or reject current spending programmes due to the lack of funding.
Governments are recommended to continue with the investment projects,
especially one with “long – run justification” such as for environmental protection
purposes, and are especially encouraged to take a larger share in the private –
public partnership projects that would otherwise be delayed or unimplemented
due to the lack of private capital. At the same time, they are proposing the
support to troubled industries hit by the crises.
23 So called squeezing effect, which implies that increased government borrowing on the market leads to
redistribution of funds from the private sector, i.e. reducing the amount of available money for the private
sector and increasing the interest rates.
24 See for details: World Economic Outlook - Financial Stress, Downturns, and Recoveries, International
Monetary Fund, October 2008, Chapter 5 - Fiscal Policy as a Countercyclical Tool, pages 159-195.
25 Antonio Spilimbergo, Steve Symansky, Olivier Blanchard, and Carlo Cottarelli, “Fiscal Policy for the
Crisis”, IMF Staff Position Note, December 29, 2008.
The recommendation is that the public sector wage increases should be avoided
as they are not well targeted, difficult to reverse, and similar to transfers to
individuals. However, the IMF is stressing that a temporary increase in public
sector employment associated with some of new programs and policies may be
By considering the fiscal package, in current circumstances, according to the
IMF's recommendations, the increase in spending and targeted tax cuts and
transfer has the highest multiplier. Generally the taxes or subsidies cuts, both for
the consumers and the companies have smaller multiplier. The IMF's is
emphasizing that in theory, public spending on goods and services has larger
multiplier effects and, most important in the current circumstances, its first round
effects are more certain than those related to transfers or tax cuts.
In order to avoid the public debt medium-term unsustainability, and to prevent
the long term negative consequences of measures, it is suggested that they are
structured so as to: increase in expenditures and / or decrease in income is
temporary subjected to later abolition without encountering major "cost"; to
increase the effects of automatic stabilizers, implementation of policies that
eliminate distortion; to introduce fiscal medium – term fiscal framework that would
cover 4-5 years, to improve expenditures and public debt management, etc.
It is interesting that the IMF’s recommendations are not corresponding to the
findings of their own study. The World Economic Outlook from 2008, the IMF26,
among other things, focuses on the following questions: should the fiscal policy
be used as an instrument of struggle with the business cycles, especially in
situations of declining economic activity? Whether the discretionary fiscal policy
can successfully stimulate the economic activity or it can harm it? The general
conclusion arising from the findings of this study is that the discretionary fiscal
policy is not successfully stimulating the economic activity in time of the crisis.
Positive effects of fiscal stimulus, if any, are modest, being more visible and
pronounced in economically developed countries against the emerging markets
The IMF’s study includes 21 developed and 20 emerging markets, and covers
the period 1970 - 2007. The research covers the period of economic
deceleration, and subject to analysis were the situation in which a state did not
react by the discretionary fiscal policy and situation in which the state reacted by
the discretionary fiscal policy, on the side of revenues and/or expenditures.
Conclusions of this study are as follows. Generally, growth rates are higher in
situations without the fiscal stimulus. In situations in which the fiscal stimulus was
implemented, better performances were recorded by the states that directed their
26 World Economic Outlook - Financial Stress, Downturns, and Recoveries, International Monetary Fund,
discretionary fiscal policy to tax cuts than those states directing the fiscal
stimulus to the increase in expenditures. The first ones recorded faster recovery
and higher growth rates in years after the crisis. The increase in expenditure has
led to the negative effects in emerging markets after three years, mostly due to
the fact that once implemented expenditures increase policy is difficult to change
later on. For developed economies, the expenditure increase policy is moderately
countercyclical. A stimulus based on tax cuts has proven to be more efficient in
increasing the economic activity than the increase in expenditures, especially in
the emerging markets.
The impact of the negative fiscal deficit and increased state debt on a long-term
growth, was documented by numerous empirical studies. The impact fiscal deficit
impact assessment to the economic growth was made by the World Bank27, for
Eastern Europe and Central Asia (ECA). The Assessment is indicating that the
fiscal deficit increases the instability of business environment, generating
negative impact on investment climate, which is particularly sensitive when the
ECA countries are, exposed to strong globalization forces and when they are
trying to attract domestic and foreign investments. The economic instability in the
ECA countries has been for years ranked as the top business threat. At the same
time, the econometric analysis is reaffirming that the lower fiscal deficit is
ensuring higher growth. The World Bank Study is indicating the analysis showing
that the fiscal balance improvement by 1 percentage point of GDP leads to the
increase in GDP growth rate at the average by 0.4 to 0.5 percentage points or
cumulatively reaches 4.6 percentage points of GDP for ten years.
The question to be posed is, why most states fiscally intervene if the experience
and relevant researches are suggesting that such intervention is inefficient? The
answer can be found in: the fear of not undertaking actions when there is a
pressure and expectation to undertaken; tendency of politicians to redistribute
and manage, increasing their powers and influence; environment for intervention
created by the international organization through their recommendations, cries
and criticism to the state to help as much and as soon as possible; as well as
due to the methods copied from the big developed countries that were first in
introducing the interventionism.
Furthermore, the question may be posed that if the states are fiscally intervening,
why they fail to do it in a more efficient and sustainable manner such as the tax
and spending cuts, and it is commonly the opposite? Even here, a part of
explanation interrelates with the public and international institution’s pressures,
coping effects, but more importantly in the tendency of politicians to (over) spend,
to present them and to leave a mark with their actions. Tax cuts are always less
visible and for an average voter is more acceptable than the bridge construction,
road paving and repair or direct social and other budgetary benefits. Increase in
spending is often generally acceptable by the majority of voters (citizens), and its
27 The World Bank, Fiscal Policy and Economic Growth: Lessons for Eastern Europe and Central Asia,
cuts become the burning issue when it induced fall in salaries and pensions,
being socially and politically problematic.
Politicians are in hunger for public spending. Despite experienced and affirmed
negations of this policy benefits, the appetite is increasing at the times of the
crises. The dangerous faith in the omnipotence of the state and effectiveness of
its interventions is not fading away. Just recently, Milton Friedman has claimed
that the world has adopted the concept of freedom, and that the socialism which
traditionally implies the state ownership and production means management can
not be repeated. It seems that he was not farsighted. The history is repeating.
The increase in unemployment and problems in companies are generating
pressure for providing greater social contributions and subsidies. Individuals and
interest groups are using the crises as an excuse for justifying their failures and
the opportunity to realize personal benefits at the expense of taxpayers and
under the general interest slogan. Multilateral institutions are using the
opportunity for repositioning, and macroeconomists for expressing their own
creativity. They all agree in requirement for state support and assistance. Thus
the current global economic crisis has brought the new global pressure for the
state intervention. The new protectionism demands wave has risen.
Nationalization and the support to private companies are policies implemented by
the richest states whose pillars of developments were economic freedoms,
market economy and private property.
States are competing in the bounty of its measures aimed at rescuing the
economy. Fiscal packages, aimed at protecting spending, production and
employment, are considered last resort. Billions of Euros and U.S. Dollars were
as oil sprinkled to the fire. It was empirically experienced that the economy
stimulus through the greater budgetary spending is just generating higher public
debt, and funds are often used by the decision makers for the support of
preferred individual projects and to meet the needs of the interest groups. Even
qualitatively designed and efficiently implemented fiscal stimulus represent
irreversible increase government spending, which in the long run hampers the
growth and the development. Simultaneously, the fiscal stimulus can not allow
market selection of healthy and sick of business entities. Some are artificially
maintained in life, and the other are suffocating and pushing down possible
healthy growth and development. Subsequently, all chances in the long run are
reduced to a vicious circle of state redistribution. The best illustration to this is the
experience of Japan, which for decades is losing the battle to revive the economy
though the state intervention, and the constant result is stagnation and growth of
Required fiscal answer at the time of the economic crises corresponds to the one
at the time of the economic prosperity – decrease in taxes and decrease in public
spending. Almost all rich countries of the world, all transitional and fast-growing
economies are spending significantly above the measure for healthy, sustainable
and long term economic growth. By intensifying spending, the state not only
spent excessively, but it created the feeling and the environment that this is
possible and desirable in the private sector. The mass of unrealistic expectations
has shattered, suddenly and unexpectedly as it usually happens. The economic
prosperity may not be built on scattered pieces. It is necessary to return to old
and proven recipes, and not to repeat sinful policies in recent past that proved to
1. International Monetary Fund. October 2008. World Economic Outlook.
Financial Stress, Downturns, and Recoveries.
2. Antonio Spilimbergo, Steve Symansky, Olivier Blanchard, and Carlo
Cottarelli. December 29, 2008. Fiscal Policy for the Crisis. IMF Staff
3. Carmen M. Reinhart and Kenneth S. Rogoff. February 5, 2008. Is the
2007 U.S. Sub-Prime Financial Crisis So Different? An International
4. Carmen M. Reinhart and Kenneth S. Rogoff. December 19, 2008. The
Aftermath of Financial Crises.
5. Capital Flows to Emerging Market Economies. January 27, 2009. Institute
of International Finance.
6. The World Bank. 2007. Fiscal Policy and Economic Growth: Lessons for
Eastern Europe and Central Asia.
7. Campbell R. McConnell and Stanley L. Brue. 1999. Macroeconomics,
8. United Nations Department of Economic and Social Affairs. January 2009.
Massive, globally coordinated fiscal stimulus is needed: going from the
drawing board to swift action. UN-DESA Policy Brief No.11.