Iceland — better known for its geothermal hot springs, abundant fish, all-night raves and eclectic musicians such as Björk andSigur Rós – has now become renowned for something else: It is the first catastrophic, and perhaps most unlikely, casualty of the 2008 economic and financial meltdown.
What on earth happened to get
It turns out that
Friedman may be dead now, but the economic and financial collapse of 2008 is becoming a real-life battleground of his theories against those of the other giant of 20th century economics, John Maynard Keynes, and their respective followers. Will financial market bailouts put the economy back on track, or are more extensive reform and a more active role for the government needed?
Keynes’ analysis was complicated and nuanced. The work for which he’s best known, The General Theory of Employment, Interest, and Money, provided a theoretical basis for the economic reforms of the New Deal era — investments in public works and deficit spending that helped countries recover from the Great Depression.
While Keynes did not dismiss the role of monetary policy in countering an economic downturn, some of his followers, notably recent 2008 Nobel economics prize winner Paul Krugman, inrelation to Japan, have focused on the possibility of a "liquidity trap" that makes traditional monetary policies, such as cutting interest rates, ineffective.
Keynes’ theories, though often misapplied, provided the basis for most macroeconomic policies in the capitalist world from the 1930s until the 1970s when the oil-price shock and stagflation hit.
Friedman, in his Monetary History of the United States, argued that the Great Depression was primarily caused by negligence by monetary authorities, such as the U.S. Federal Reserve, who didn’t do enough to respond to an ordinary financial shock by expanding the money supply.
Friedman and his
While Friedman’s narrow form of money supply monetarism was quickly abandoned in the early 1980s, most governments have relied primarily on monetary instead of fiscal policy for stabilization of their economies over the past few decades. This turned Alan Greenspan, former head of the U.S. Federal Reserve and an advocate of Friedman’s policies, into the most important economic policy maker in the world. Although Greenspan was never elected, had no particular expertise in economics and was a disciple of the fringe ideology of libertarian Ayn Rand, he was able to use his considerable power to endorse tax cuts and deregulation. He is now widely considered to share the blame for creating the conditions that resulted in the current economic collapse.
Greenspan’s successor as chair of the Federal Reserve, Ben Bernanke, is also a follower of Friedman, but he is an accomplished economist. Coincidentally enough, one of his areas of expertise was in the economics of the Great Depression; he once boldly stated that the Federal Reserve was responsible for causing the Great Depression and making banking panics during it "much more severe and widespread."
Bernanke is now one of the people in charge of what is probably the most expensive experiment in human history: trying to avert another Depression, using economic policies inspired by Friedman. The cost of this to the U.S. Treasury so far has already reached well over $1 trillion and continues to rise.
So how did the much smaller but perhaps more ambitious experiment with Friedmanite economic policies fare in tiny
Under the leadership of Prime Minister David Oddsson and explicitly inspired by Friedman, Iceland’s neoconservative young Turks implemented a radical (but now familiar) program of privatization, tax cuts, reductions in spending and deficits, inflation targeting, central bank independence, free trade and exchange rate flexibility. Corporate taxes were cut from 50 percent down to 18 percent. Privatization and deregulation were driven directly through the prime minister’s office, and the major banks were privatized.
Economic missions and reports on
It wasn’t as if everyone was unaware of the growing dangers of these policies. In 2001, Joseph Stiglitz, recipient of the Nobel prizein economics and one of the leading lights of the "New Keynesian" school of economics, wrote a remarkably prescient paper for the Central Bank of
Stiglitz’s paper (PDF) has invaluable advice that should have been considered by any nation — and especially
At first, the policies appeared to be very successful. The economy grew at a strong pace, rising until
Icelandic banks and businesses, with the support of their government, expanded aggressively overseas, particularly into the
Then it all came crashing down.
Inflation and short-term interest rates escalated to 14 percent, and
Back in the
Stock markets didn’t start to recover until European nations moved to effectively nationalize their major banks. This move was quickly followed by
What is somewhat incredible is the apparent lack of remorse or self-reflection and doubt being expressed by the ideologues whoput these policies in place. Amazingly, many neocons continue to argue that the financial collapse was caused by regulations that were too strong, or by a confluence of unlikely events, including a rise in "leftist attitudes."
There seems to be a belief among many that a financial market bailout will soon relieve the credit crunch caused by the subprime fiasco and then we can go back to business as usual. We don’t need to look too far back in time or too far abroad to see how misguided these views are. Clearly it is time to broaden our horizons, learn from Keynes and successful New Deal economic policies, and consider other imaginative solutions to our economic crisis.
Toby Sanger is an economist with the Canadian