Transcript | 4. lecture: What Did Governments Do and Why? - University for modern Slovakia

Last lecture described the way how the U.S. mortgage bubble turned into a global financial crisis. We showed that this was mainly due to two relatively new phenomena - new financial products and global nature of financial markets. Today we take a look at how governments around the world reacted to the financial crisis and why they did what they did. The U.S. economy was not only at the epicentre of the crisis, but has been and still is by far the strongest economy in the world. The eyes of the world were thus on the United States and on how they handle the crisis.

A key role in drafting anti-crisis measures was played by Ben Bernanke, who took the chair of the Fed Chairman after Alan Greenspan. Bernanke previously served as professor of economics at Princeton University and was an acknowledged expert on the Great Depression. The opinion that he is the right man to handle the crisis was prevailing and still is. Krugman writes that "no one else is more intellectually ready for the situation we are facing". And it seemed that it was really so.

The global financial crisis was compared to the Great Depression brought under control more quickly, with lower costs, losses and casualties. The only but crucial question however remains to be answered, which is whether the crisis is really behind us, and if it is, what is the price that we will have to pay?

In other words, it is quite obvious that the costs in terms of economic decline, unemployment, bankruptcies, etc., were in the years 2008 - 2010 significantly lower than in the years 1929 - 1933. The question is whether it is the right time to do the accounts and whether these accounts will not worsen over time due to the way the crisis was resolved. .

Briefly let us mention the approaches of Bernanke, Krugman and Obama (as well as Bush) to the situation and what the Austrian School has to say about the matter. The mainstream economic direction argues that the Great Depression would not have nearly as devastating and long-term consequences if the FED and the government had not failed. The failure lies in the fact that, under the doctrine of free markets and limited government intervention, FED did not intervene and inject money into the economy, even did the opposite, which resulted in the collapse of financial markets and consequently the real economy.

The official version, which is taught in most schools in the United States, but worldwide as well, is that the United States and the world were dragged into the crisis by the ring-wing President Hoover, who was blinded by free market ideology. It was his successor, Franklin Delano Roosevelt after this accession in 1933, who saved the world and the United States thanks to his ambitious plan called the New Deal, which meant more public investment, higher taxes and higher price interventions.

Thus, more state and less market. Paul Krugman begins his book The Return of the Depression Economics and the Crisis with these words, I quote: "Most economists, to the extent that they think about the subject at all, regard the Great Depression of the 1930s as a gratuitous, unnecessary tragedy. If only Herbert Hoover hadn't tried to balance the budget in the face of an economic slump; if only the Federal Reserve hadn't defended the gold standard at the expense of the domestic economy; if only officials had rushed cash to threatened banks, and thus calmed the bank panic that developed in 1930-1931; then the stock market crash of 1929 would have led only to a garden-variety recession, soon forgotten."

The Austrian school sees it differently and argues that President Hoover in 1929 - 1933 made such anti-market interventions to the economy like never before in times of peace: increased taxes, introduction of public works projects, provisions of emergency loans for failing businesses, stricter limitation of freedom of international trade, regulation of salaries at an artificially high level, while consumer prices were dropping. It is ironic that F.D. Roosevelt, during the presidential campaign in 1932, had accused Hoover that he is "the biggest peaceful money-spender in the history of the United States". Roosevelt's candidate for Vice President said it every clearly, when he said: "Hoover is leading the country into the socialism

The reality was that when Roosevelt became president, he significantly deepened and broadened interventionist and statist policies of his predecessor. One of the key Roosevelt advisors Rexford Tugwell later admitted that many of the programs that made up the New Del were just an extended Hoover's policies. Roosevelt only further increased taxes and the regulation of prices and wages, expanded public works and introduced federal social programs.

The Austrian School argues that both Hoover and Roosevelt were preventing the bubble to deflate naturally, thus prolonging the recession and total costs of the crisis. In other words, if they were not preventing the deflation of the bubble and let markets to clear up, the decline would be deeper, but much shorter and the costs that would be borne by people would be significantly lower. There is extensive literature that factually demonstrates that the Great Depression lasted so long not despite of the New Deal, but because of it.

As an example of a good approach, the Austrian School mentions the U.S. crisis in 1920 - 1921. From mid 1920 to mid 1921, the industry fell by 21%, which was more than during the first year of the Great Depression. The U.S. government did not intervene and let markets to clean up and after several months the economy was growing again. So, summarized and underlined, the views of Keynesians and Austrian Schools on the causes of the Great Depression and on necessary responses of governments and central banks could hardly be more different.

This is best seen on an assessment of what President Hoover did or did not. Today it is clear which school prevailed - Obama, Bernanke, Krugman, under the Keynesian flag, determine the direction of the world's economy. Hundreds of billions of dollars and euro are being injected through different rescue packages to banks, companies and even countries. American is a leader again, and Europe is reluctantly, but nevertheless following the trend. Where will it lead? In the next lecture, we will explain the views of the Austrian School.