Did Stimulus Prove More Effective Than Austerity After 2008?

The Policy Divide

The 2008 Global Financial Crisis forced governments into a stark policy choice. The U.S. and China pursued Keynesian stimulus, injecting liquidity into their economies. The U.S. allocated nearly $800 billion via the American Recovery and Reinvestment Act (ARRA, 2009).

However, the U.K. and Eurozone generally opted for austerity, slashing spending and raising taxes to curb deficits. The rationale was that fiscal consolidation would restore investor confidence and prevent sovereign debt crises.

Did Keynesian Stimulus Work?

Keynesian theory argues that government spending boosts demand in recessions, helping to prevent deflationary spirals. However, despite large-scale stimulus in the U.S., inflation remained fairly muted, suggesting that even aggressive monetary and fiscal policies could not fully offset the economic downturn.

Why? A liquidity trap, where banks hoarded reserves, and households prioritised debt repayment over spending, preventing stimulus from circulating through the economy (Eggertsson & Krugman, 2012).

Austerity & its Weaknesses

Austerity supporters, such as U.K. Chancellor George Osborne, believed spending cuts would rebuild market confidence. The theory of “expansionary austerity” (Alesina & Ardagna, 2010) suggested deficit reduction could even stimulate growth.

However, critics, including the IMF, later found the economic damage was greater than expected. Fiscal multipliers were underestimated, making austerity more harmful than policymakers predicted (Blanchard & Leigh, 2013).

The Eurozone’s Dilemma: No Currency Devaluation

For Eurozone nations (Portugal, Italy, Ireland, Greece, Spain - PIIGS), austerity was even more painful. Unlike the U.S. and U.K., they could not devalue their currency to boost competitiveness. Instead, they resorted to internal devaluation by cutting wages and public spending (Duman, 2018). 

This prolonged recessions and fuelled social unrest. Meanwhile, U.S. stimulus policies spurred a quicker recovery with U.S. GDP returning to pre-crisis levels by 2015, with only modest inflation (Krugman, 2012 / 'End This Depression Now!').

GDP Growth Rate (%) U.S. Vs. E.U. (Source: Statistic Times)

Austerity: A Necessary Evil or a Mistake?

While austerity helped stabilise debt, it came at the cost of weaker growth, public services, and wages. The contrast between U.S. stimulus and Europe’s austerity shows how fiscal policies shape recoveries.