Unfortunately, rather than lend this additional money, the banks used it to rebuild their balance sheets and pay large bonuses to their staff, so that small and medium companies were starved of investment funds. The new orthodoxy discarded these insights.
Bureaucrats aimed to line their departmental pockets; politicians to maximise their votes. Unfortunately, with hindsight it is now clear that the expansion of Northern Rock was too rapid. Some countries, such as Germany, are also experiencing sustained growth, but those that adopted stringent austerity policies, such as Ireland, Greece, Spain and Portugal, have yet to recover.
America continues to test that hypothesis in the real world, in real time, rather than speculating on the theory of austerity. It also promised to sell an additional 50 billion euros in assets by In theory, deficit reduction can be achieved by either raising taxes or reducing expenditure.
Captivated by the idea that money plays only the part allotted to it by the monetary authority, central banks failed to identify the build-up of debt in the financial sector, a fragility made worse by the octopus-like spread of derivative instruments.
The entire system rapidly unravelled, leaving those countries most dependent on financial services, such as the UK, facing the double burden of a collapse in tax revenues from the financial sector while simultaneously having to inject large sums of money into the retail banks, which were by now inextricably entwined with their much riskier investment arms, to stave off a banking collapse.
Creditors then start demanding higher interest rates to compensate them for the higher risk. Lowering government spending and laying off workers will reduce economic growth and increase unemployment.
Belt-tightening worked well during World War II, but economic circumstances then were different than they are today.