What to do about financial crisis

Although markets started the year with a cheer, the dire economic reality is currently taking precedent over wishful thinking that "the worst is over".

Deleveraging is ongoing. Sales are declining, contributing to an increase of deflationary pressures.

Credit remains tight, with banks reticent to lend despite unprecedented guarantees and liquidity facilities.

With interest rates approaching zero, certain renowned economists are calling a liquidity trap, the situation whereby credit remains tight despite liquidity being nominally cheap and available. The explanation for this phenomenon can be simplified substantially: Banks expects the economy to get worse, and are tightening credit conversely. By doing this, banks are reinforcing, indeed to some extent causing this trend.

Whereas Neoclassical economics suggests exiting this situation by giving money away, enhancing demand for goods, thereby supporting economic activity, Keynesian economics suggests government infrastructure projects to achieve the same aim.

Both these approaches have the potential to help us out of the current slump. Infrastructure projects would be more likely to produce long lasting benefits, whereas giving money away may
bring less value for money due to the fact that some of the stimulus would be saved.

The current issue with both these approaches remains not their theoretical soundness, but their political feasibility. Many politicians are still unaware of how dire the situation the economy is currently in really is, and remain skeptical towards stimulus operations which are nominally enormous such as the 800bn US$ pro0grma proposed by Barack Obama. Given the persistence of failed economic ideology, there is potential for this stimulus program to be downsized or stalled to the extent that it become insufficient and fails. In Europe, the situation is even more complicated, given the decentralized political process and perceived beggar-thy-neighbour effects of localized economic stimulus. This discussion is further complicated by the fact that governments are already in severe fiscal stress, arguably due to the competitive international pressure to reduce taxes below the level of comparable nations, to improve the attractivity of the economy for the productive factor capital. This in many cases worked as planned, with capital moving to the states where the least limits and costs were imposed on its use. Unfortunately, the expected fiscal benefit often remained scant, and major governments have been compelled to borrow from future generations to fund their operations. Even today, when any neutral analyst worthy of the label should be aware of the fact that unfunded tax decreases in large, open economies are most likely to result in state funding strains, and a corresponding decrease of the capability of the state to fund their operations than in economic growth, many are still calling for tax cuts, despite their realization that bailouts are necessary.

To summarize:
The economy is in trouble.
We should better fix it.
We will then have to pay for it.