The primary cause of the 2007/8 financial crisis was private debt, especially the debts owned by private banks. This was especially focused on housing “scams” operated in concert by the banks – using bundled mortgages to create new kinds of fiscal instruments and a hitherto unknown level of debt-risk – which in turn led to a collapse of the housing market. The response to this was, world-wide, a confused fiscal policy ranging from austerity and budget cuts and stimulus coupled with low interest rates and pumping cash into the system (quantitative easing).
The new version of all of this is that it isn’t private debt that needs now to be tackled (e.g. by higher interest rates) but public debt that has to be dealt with. The rationale is that it is the level of public debt that impacts investor confidence (the so called “confidence fairy”). The trouble is that investor confidence is back as a high, but the pursuit of austerity continues. Put another way, this theory of action – the critical need to restore confidence justifies austerity – continues to drive policy, even though confidence is back. Meanwhile, the banks continue to be problematic and are developing new forms of risk ventures which will lead, at some point in the next forty eight months, to a further debacle.
How can the basic causes of the crisis now be forgotten in the rush to austerity? Why is it that a disproven economic theory (we need to do magic to call up the confidence fairy) continues to drive policy makers?