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Why the pump priming won't help the financial crisis

By Ken McKay - posted Tuesday, 27 January 2009

If it was January 27, 2008 and I made a prediction that every stock market across the world would crash losing 40 per cent in value, major economies would go into recession and face a deflation threat I would be labeled a loony left winger and probably sent to the asylum.

Well here is food for thought while economic pundits are talking about recoveries induced by stimulation packages, there will be no recovery.

Unemployment in the United States by this time next year will reach 20 per cent, the World economy will be locked into a deflationary spiral that will last as long as it takes until the major nation makes fundamental changes to economic structures across all nations.


Why won’t the pump priming work? Its worked for other depressions and major recessions.

The Keynesian response to the Great Depression involved increasing demand by government spending. Essentially, Keynes’s theory that equilibrium between supply and demand could be shifted to establish a new equilibrium with full employment was proven, so why won’t it work this time?

The Keynesian solution occurred when there were fixed exchange rates. In a floating exchange rate environment all the fiscal stimulation packages in the world will have limited effect. Over time those nations that engage in fiscal stimulation packages will see their effectiveness decrease as their currencies devalue.

Is the solution a monetarist response?

No, across the world the central banks’ first response was the traditional interest rate reduction and all that has achieved is locking every major nation into the liquidity trap of zero or negative real interest rates raising the ugly head of deflation.

To look at finding a solution we need to correctly diagnose the disease.


Well we all know the problem right? It was a speculative property market in the United States coupled with lax lending practices after the boom bust.

Wrong … These are the symptoms of the disease not the disease itself.

The disease is the decoupling of economic policy decision making from democratic institutions.

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About the Author

Ken McKay is a former Queensland Ministerial Policy Adviser now working in the Queensland Union movement. The views expressed in this article are his views and do not represent the views of past or current employers.

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