The 2008 Financial Crisis and Its Aftermath: Addressing the Next Debt Challenge

Abstract:     
We continue to struggle with the legacy of the 2008 financial crisis, which was fundamentally caused by the incurrence of too much leverage on the part of all economic participants, including individuals, private firms and financial institutions, and governments. Despite continued high unemployment and slow economic growth throughout the advanced economies, evidence shows that unprecedented government stimulus and monetary easing prevented a far worse outcome: a second Great Depression. The government response was predictable, based on historical precedent, but inadequate to compensate for the dramatic decline in private demand. As a result, while certain developing economies are likely to continue to experience strong growth, the developed world will struggle with high unemployment and slow growth for years to come. Moreover, the 2008 crisis and ensuing recession have contributed to another significant challenge facing the developed world in the coming years: an unprecedented level of government indebtedness, which is only partly reflected on governments’ balance sheets. While governments typically experience spikes in sovereign indebtedness following financial crises, the government debt problem today is made worse by looming demographic challenges in the developed world. Amid declines in working age populations across the West, the retirement of the baby boomer generation will increase demands on government pension and health programs at the worst possible time. Governments in the developed world thus must navigate a tricky balancing act of providing short term stimulus to support flagging economic growth, while mapping a course for medium and long term debt reduction. Unfortunately, in the US government has so far demonstrated an inability to address this challenge. While President Obama’s Commission on Fiscal Responsibility and Reform offers some hope for constructive solutions, there is a risk that its limited focus and partisan politics may prevent it from providing the necessary long term solutions. To increase the Commission’s prospects for success in prompting the US to plan a course for fiscal solvency, this paper proposes that Congress adopt procedures that would require it to act on the Commission’s recommendations, unless it agrees on alternative proposals to address the deficit and debt.

Number of Pages in PDF File: 211

Keywords: 2008 financial crisis, credit crisis, sovereign debt, US deficit, entitlement reform

JEL Classification: A10, E00, E6, F01, G2, H6, K2

working papers series