Fiscal Austerity Versus European Society

First, we must accept that austerity measures, necessary to avoid a fiscal train wreck, have recessionary effects on output. So, if countries in the eurozone s periphery are forced to undertake fiscal austerity, countries able to provide short term stimulus should do so and postpone their own austerity efforts.

First, front loaded fiscal austerity however necessary is accelerating the contraction, as higher taxes and lower government spending and transfer payments reduce disposable income and aggregate demand. Moreover, as the recession deepens, resulting in even wider fiscal deficits, another round of austerity will be needed.

The slump had been created by fiscal extravagance, they insisted, and therefore could be cured only by fiscal austerity. And not any old austerity it was spending on the poor, not the rich, that had to be cut, because such spending was the real cause of the trouble.

What went wrong in Greece was not the fiscal adjustment. On the contrary, austerity was perhaps too successful (and painful).

Yes, we were all Keynesians but all too briefly. Fiscal stimulus was replaced by austerity, with predictable and predicted adverse effects on economic performance.

In fact, most of the world believes that Germany should adopt a more expansive fiscal policy. According to this view, austerity is counter productive, because it induces slowdowns and recessions that make long term fiscal consolidation more difficult.

The cure, such as it was, finally came about, years behind schedule, not through fiscal bleeding, but by massive monetary stimulus. When the groggy patient eventually staggered to its feet, the champions of fiscal bleeding triumphantly proclaimed that austerity had worked.

To be effective, monetary stimulus needs to be accompanied by temporary fiscal stimulus, which is now lacking in all major economies. Indeed, the eurozone, the UK, the US, and Japan are all pursuing varying degrees of fiscal austerity and consolidation.

LOS ANGELES The debate over fiscal expansion versus consolidation continues to divide the developed world. In response to the global recession of 2008, the United Kingdom embarked on an austerity program while the United States enacted an 800 billion fiscal stimulus.

People say we should call it the fiscal slope, or we should call it an austerity crisis, but then other people say, no, that's even more partisan.

Though privatization plans lagged, the Greeks won high marks for doubling down on fiscal austerity. In Europe s summer of quiet triumphalism, ever lower expectations were easy to beat.

To be sure, one can reasonably argue that austerity in the eurozone has been excessive, and that fiscal deficits should have been much larger to sustain demand. But only governments with access to market finance can use expansionary fiscal policy to boost demand.

But Osborne is back as Chancellor, promising even tougher cuts over the next five years. And fiscal austerity is still the reigning doctrine in the eurozone, thanks to Germany.

In particular, Germany demands more fiscal belt tightening from heavily indebted Southern European countries, whose unions (and voters) are rejecting further austerity. While the US has thus far avoided the bond market s wrath, American political leaders confront the same problem of debt and fiscal sustainability.

America is suffering the consequences of a generation long effort to render the state illegitimate as an economic actor. Europe is mired in its oxymoronic commitment to expansionary fiscal austerity.

So the problem is not that austerity was tried and failed in Greece. It is that, despite unprecedented international generosity, fiscal policy was completely out of control and needed major adjustments.

In particular, Germany demands more fiscal belt tightening from heavily indebted Southern European countries, whose unions (and voters) are rejecting further austerity. While the US has thus far avoided the bond market s wrath, American political leaders confront the same problem of debt and fiscal sustainability. nbsp

There is exactly zero evidence in Europe today that inflation is just around the corner. And, if current European governments are not committed to austerity and fiscal consolidation, then which governments are?

The belief that the fiscal multiplier is usually low may have contributed to underestimation of the short run economic costs of austerity policies and thus to persistently optimistic forecasts of growth and employment. Recent research by the International Monetary Fund on the context specific variability of fiscal multipliers has raised serious questions about the costs and effectiveness of rapid fiscal consolidation.

After Austerity

The economic headwinds are formidable fiscal austerity, high interest rates outside AAA rated countries, credit cutting by banks, deleveraging households, weak private sector investment, and declining exports as the global slowdown undermines demand.

But growth prospects could be undermined by another bruising political battle over the federal budget, resulting in deep spending cuts. The current Republican rhetoric in the House of Representatives portends additional fiscal austerity.

But phasing in austerity more gradually, and thus back loading the adjustment, would have posed less risk to the economy s anemic recovery while maintaining a credible commitment to fiscal consolidation. Instead, the government could well end up with no plan B in case plan A massively front loaded austerity leads to a double dip recession.

Counterproductive and excessive fiscal austerity at the federal level has dampened growth this year, but the private sector has proved more resilient than expected. Under current law, fiscal contraction is slated to ease next year and monetary policy is likely to remain supportive, so most forecasters predict an acceleration of growth.

To reduce the risk of financial pressures on Italy and Spain, both countries need to press ahead with fiscal austerity and structural reforms. Moreover, their debt could be ring fenced with a larger package of EFSF resources and or with the issuance of Eurobonds a further step towards European fiscal integration.

To prevent a disorderly outcome in the eurozone, today s fiscal austerity should be much more gradual, a growth compact should complement the EU s new fiscal compact, and a fiscal union with debt mutualization (Eurobonds) should be implemented. In addition, a full banking union, starting with eurozone wide deposit insurance, should be initiated, and moves toward greater political integration must be considered, even as Greece leaves the eurozone.

Europe s Austerity Zombies

The Austerity Pandemic

Clarity about Austerity

Misconceiving British Austerity

Austerity and Demoralization

End Austerity Now

The demand school might respond that, regardless of whether there is fiscal austerity now, increased government spending (financed, of course, by debt) would impart a permanent boost to employment. But Greece s recent experience suggests otherwise.

If public sector deleveraging is not a complete growth policy and it isn t why is there so much attention on fiscal austerity and so little action (as opposed to lip service) on growth and employment?

Outside the eurozone, even the United Kingdom is struggling to restore growth, owing to the damage caused by front loaded fiscal consolidation efforts, while anti austerity sentiment is also mounting in Bulgaria, Romania, and Hungary.

Government s mounting debts have been a response to the economic downturn, not its cause. What ought to have been hard wired into the EU s institutional structure was not permanent fiscal austerity, but tough financial regulation.

Lagarde was apologizing for the IMF s poor forecasting of the United Kingdom s recent economic performance, and, more seriously, for the Fund s longer standing criticism of the fiscal austerity pursued by Prime Minister David Cameron s government. Now endorsing British austerity, Lagarde said that it had increased confidence in the UK s economic prospects, thereby spurring the recent recovery.

But in the current crisis, the academic evidence has overwhelmingly shown that fiscal austerity does what textbook economics says it will do the more severe the austerity, the greater the drag on growth. A variety of studies confirming this proposition, including one by the IMF s chief economist, Olivier Blanchard, have withstood considerable scrutiny and leave little room for ambiguity.

A true Keynesian would have said that what was needed in 2010 was fiscal expansion, not consolidation. Osborne believed, or appeared to believe, that austerity would speed up economic recovery, by restoring confidence in government finance.

What is required is a two pronged approach that targets both problems simultaneously. The prevailing approach targeting debt through fiscal austerity and competitiveness through structural reform has produced unemployment levels that threaten social and political stability.

The Greek Austerity Myth

Asia s Take on Austerity

Austerity and Debt Realism

Europe s Irrelevant Austerity Debate