As Obamamania took hold during the early days of his presidency (and even before), the US electorate seemed to be relatively satisfied with the all-guns-blazing approach to tackling the crisis. As he is not George W Bush, we are not, thankfully, talking about Iraq

The media in the US seems rather unaware of how mixed the responses to the crisis are in the rest of the world. China announced strong measures which were subsequently understood to be a re-packaging exercise of already budgeted spending. Germany, the economic core of the European Union, has taken a rather conservative approach. France, keen to protect its national champions, offered capital injections to avoid some significant likely bankruptcies. Spain is currently debating whether to significantly increase its budget deficit to stimulate its economy and draw the wrath of the European Commission in the process.

So what is the best approach is to tackle this crisis? It is true that fiscal stimulus is needed to counter a sharp downward swing, but that is a typical counter-cyclical approach. What we are seeing here is the precipitous correction of a huge credit bubble in (mostly) anglo-saxon countries, partly financed by a savings glut in China and elsewhere. Japan has already had to face a similar situation when its asset price bubbles (including Japanese property and the Tokyo stock market) burst in the early 1990’s. Japan entered a prolonged economic stagnation, also known as the “lost decade”, despite huge stimulus measures (although some were ill-conceived). The legacy of that stimulus has led to Japan’s dubious honour of being the world leader in public debt among developed nations- approaching 200% of GDP. Its “lost decade” is now turning into its “lost quarter-century”.

Ireland, although small, presents an interesting case. In a previous post, I addressed the fiscal crisis with regard to Ireland’s public finances. It is accepted wisdom in Ireland that the over-riding priority is to stabilise public finances to maintain the confidence of the markets and to avoid being obliged to seek a bailout. This situation was inevitable due to the huge risky bet – now gone sour – that the country’s banking system collectively placed on the property sector. It is clear that the austerity measures will remove demand, however, Ireland’s economic policy-makers have no choice but to reverse previous policy and harshly cut spending and increase taxes despite the…

… fear of a demand-led collapse if spending were to be cut on a public or private level – thus realising a Keynesian Paradox of Thrift. On the contrary – the collapse is due to de-leveraging of the credit bubble and cannot be stopped. It can only be managed, to moderate its worse effects.

Of course, it will only be possible to determine if this is actually a successful course of action in hindsight, once the crisis has ended. Greece, a small economy with a similar risk profile to Ireland at present (although for different reasons), is taking the opposite approach, as reported by the Sunday Tribune.

Significantly, Greece, whose debt pile is larger than ours, raised €7.5bn last Wednesday from selling long-dated 10-year bonds by paying a huge interest rate. The National Treasury Management Agency here appears unwilling as yet to pay huge premia to raise new money.

They intend to spend their way out of this crisis and they are paying the elevated risk premium on the debt they are currently issuing. Obviously, they will be in  worse shape than Ireland from the point of view of public finances, although it is probable that further bad news from the Irish banks may mean continued fiscal crisis in Ireland and an unavoidable increase in national debt. As is the case with the US, future generations will be burdened with the new debt now accumulating. The Irish approach will mean an even worse recession – approaching levels normally associated with an economic depression, however, it could be argued that the adjustment in Ireland, while difficult, will be swifter and more effective, because it will focus on de-leveraging – the unwinding of the credit bubble.  It remains to be seen which approach will work.