What is a crisis? A crisis is a concept that in general terms refers to a severe disturbance, and in economics, it is no different. Economic crises are those moments in which, for a wide variety of reasons, the economic variables become destabilized.

How to identify a crisis? The most common indicators of a crisis are the economic imbalances that manifest as increasing levels of unemployment, inflation, business inactivity, poverty, etc. In this sense, crises may occur as a natural moment in the economic cycle; or they may be the consequence of specific shocks, most commonly in the last decades as a product of globalised economic dynamics.

How to manage an economic crisis?

In these situations, when the imbalances come to produce a crisis in an economy, public policies have the responsibility to stabilize the countries’ economic growth. How to do it in the best way is the question that economists and policymakers ask themselves, and, as it is easy to imagine, the formulas for action are not always consistent with one another. Each school of economic theory formulates different hypotheses, and therefore different conclusions and practical recommendations.

The two models of general reference in economics are the Neoclassical school on the one hand and Keynesian on the other. To face economic imbalances the recommendations of the two models and the economic policy suggested would be different due to the fact that  they depart from different assumptions of how the economy works.

The economic policy of the Neoclassical school rejects employing incentives to increase public spending – or in economic terms, ‘the incentive on the aggregate demand that is managed mainly by the fiscal policy’ . This is because this school believes that public spending would produce price increases as it assumes the economy is always at its full employment level -and therefore supply could not increase-.  According to  neoclassical theory, situations of imbalance are rectified by the flexibility of prices and by the automatic mechanisms of the market.

On the contrary, for the Keynesians, the main instrument with which to intervene in the economy is indeed the fiscal policy. This is because it is the most effective instrument for counter-cyclical measures,  directly impacting the aggregate demand. The variations in public spending (by granting subsidies, lowering taxes, etc.) lead to an increase in people’s income which is considered to surely lead to an increase in consumption. Increased expectations leads to a further increase in investment. These series of chain reactions take place in a way that, in the end, the increases in income and GDP are greater than those initially generated by the public spending, due to what Keynesians call the ‘multiplier effect’. Therefore, managing the fiscal policy and with it, the aggregate demand, is how this model suggests generating the necessary changes that an imbalanced economic situation might require.

Are those the only schools/lines of action? 

Economic science does not constitute a homogeneous and generally accepted body of knowledge. The concerns and the answers to economic problems differ according to the schools of thought and, naturally, according to the position or the interest that explicitly or implicitly is assumed by the researchers. The two lines presented above (Neoclassical and Keynesian) and under which we will erect this dossier, constitute the opposite points of a wide spectrum that includes other economic schools that are distributed closer to one or the other.

For example, the monetarist school (also known as the Chicago school) is an important current that strongly criticized the weight of the State in the economy, as well as the use of fiscal mechanisms as the main instrument for dealing with economic imbalances. Led by Milton Friedman, this anti-interventionist current supported the autonomous logic of the market and an economic policy centred on monetary policy instruments. Therefore it is clearly situated on the spectrum next to the neoclassical current.

On the other end of the spectrum, the post-Keynesian economy has given more strength to four elements in Keynes’ initial analysis: income distribution, financial institutions, and trade unions and multinational companies. According to this school, which is logically closer to Keynesian theories, in times of crisis fiscal policy should be used to ensure that the level of aggregate demand is such as to ensure full employment. So far this aligns with Keynes’ original position, but differs in that it advocates designing an economic policy mix that combines wage policy with a robust redistribution mechanism, and adds a recognition of the need for a downsizing and restructuring of the financial system.

Apart from these two schools, and without forgetting the classical and Marxist roots, alternative currents have not ceased to proliferate, calling for a different reading of economic problems.  Among them we can find the structuralist school, the institutionalist school, the ecological economy and the feminist perspective. All these pathways are located closer to or further from the Neoclassical or Keynesian political choices of crisis management depending on their similarity to the aforementioned, and will be the subject of our chapter on economic theories.

Why is it important to understand how crises are managed? 

1. To understand different interests. It is important to bear in mind that these two opposing models (the Neoclassical and the Keynesian together with the other many in the middle) respond to a debate that is not only regarding different economic theories, but also ideologies and political options. Neither ideologies nor political options are tethered  to specific economic interests. Rather, ideologies and political options are directly framed by the interests of different groups and their power capacity. This means that the real battle is one of redistribution: who bears the burden of loss in a crisis?

The impacts on the different social sectors might be quite different if, for example public policies chose to stabilize the countries’ economic growth by means of counter-cyclical measures while using instruments to protect the most vulnerable sectors; or if instead governments decide to let the market arrange the imbalances by its own while bailing out the bankrupted banks and financial creditors. Understanding this will be useful to anyone who is concerned about who is harmed and who benefits from the different possible strategies. In the end, all economic policy measures are conditioned by value judgments and ideological assumptions and, above all, by the dominance of one or the other interests in the social system.

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Nick Anderson

1. To recap what we have not learnt so far. In general, the overall approach of formal education (mainly via textbooks) bases its response to  the economic concept of crisis on the neo-liberal economic paradigm.  The market is seen as the basic self-balancing instrument which contains rational agents seeking to maximize profits and income, encouraging individualistic, utilitarian behaviour.

In this context, crises always tend to be explained in a mechanical way, framed within various thematic concepts linked to growth and economic cycles, macroeconomics and public sector intervention, without explaining the causes of the crises or the point of contact with reality. That is, without exploring the direct effects that one or another crisis management strategy may have on our daily lives, nor questioning who benefits and who suffers in each situation. Therefore, this dossier aims to challenge that pattern of learning, hoping to awaken the student’s critical view of the different ways of dealing with economic problems that exist in today’s world.

1. To understand the past. All throughout the 20th century, the empirical evidence portrays a highly unstable evolution of capitalist economies over time, where economic crises have occurred consistently and with increased frequency. The Great Depression after the crash of 1929, the oil crisis of the beginning of the 1970s and the 2008 financial crisis are some examples of global economic crises, albeit with different triggers (interest rate movements, changes in the costs of production, the explosion of speculative financial bubbles). What’s more, each lasted for a different period of time.

A conservative policy response was what came to dominate political economy management of economic crises since the 1970s. Policies focused on reducing public deficits, cutting public spending, controlling wages and devaluing the national currency have constituted the basis of austerity plans implemented in many European countries after the 2008 crisis.

Austerity means the cessation or reduction of public spending. Ultimately it means the retreat of the State as a social benefactor that injects resources into the economy. The problem is that these austerity policies have not been able to guarantee enduring stability and well-being, nor have they avoided major economic problems, such as mass unemployment, the waste of resources, poverty and inequality. Therefore, it is worth questioning to what extent austerity is the correct strategy to use in a crisis.

1. To understand the future. Currently, while this dossier is being produced, an unexpected and abrupt change in the role of the State is taking place as a result of the exceptional crisis generated by the COVID-19 virus. Governments in almost every country of the world have been and continue to be faced with difficult trade-offs between the health, economic and social challenges that arise as result of the pandemic. Many national and subnational governments have reacted quickly to address the economic and fiscal consequences of the crisis, and countries are spending significantly more than they did in 2008-2009. Two-thirds of OECD countries have, for example, adopted measures in support of subnational government finance (OECD, 2020).

The use of public investment across all levels of government to support a COVID-19 recovery over time represents a completely different scenario to the one promulgated by advocates of austerity that supported a  reduction in public spending and a targeting of inflation above all else. Although it is still too early to deeply understand how this crisis was managed and whether the increased presence of the State as an investor in the economy is here to stay, it is encouraging to witness how in some countries, the objectives of economic recovery are being tied to social and climate goals.

KEYWORDS

• Crisis
• Economic Policy
• Regulation
• Aggregate Demand
• Welfare State
• Public investment
• Neoliberalism
• Austerity