Crisis economics! A return to the abyss.

• Author: Roubini, Nouriel

One interpretation of financial crises is that they are, in Nassim Taleb's phrase, "black swan" events--unplanned and unpredictable occurrences that change the course of history. But, in my new book on financial crises, Crisis Economics (Penguin, 2010)--which covers not only the recent crisis, but also dozens of others throughout history and across both advanced economies and emerging markets--I show that financial crises are, instead, predictable "white swan" events. What is happening now--the second stage of the global financial crisis--was no less predictable.

Crises are the inevitable result of a build-up of macroeconomic, financial, and policy risks and vulnerabilities: asset bubbles, excessive risk-taking and leverage, credit booms, loose money, lack of proper supervision and regulation of the financial system, greed, and risky investments by banks and other financial institutions.

History also suggests that financial crises tend to morph over time. Crises like those we have recently endured were initially driven by excessive debt and leverage among private-sector agents--households, banks and financial institutions, corporate firms. This eventually led to a re-leveraging of the public sector as fiscal stimulus and socialization of private losses--bail-out programs--caused a dangerous rise in budget deficits and the stock of public debt.

While such fiscal stimulus and bailouts may have been necessary to prevent the Great Recession from turning into Great Depression II, piling public debt on top of private debt carries a high cost. Eventually those large deficits and debts need to be reduced through higher taxes and lower spending, and such austerity--necessary to avoid a fiscal crisis--tends to slow economic recovery in the short run. If fiscal imbalances are not addressed through spending cuts and revenue increases, only two options remain: inflation for countries that borrow in their own currency and can monetize their deficits; or default for countries that borrow in a foreign currency or can't print their own.

Thus, the recent events in Greece, Portugal, Ireland, Italy, and Spain are but the second stage of the recent global financial crisis. The socialization of private losses and fiscal laxity aimed at stimulating economies in a slump have led to a dangerous build-up of public budget deficits and debt. So the recent global financial crisis is not over: it has instead reached a new and more dangerous stage.

Indeed, a practical...