Wednesday 22 May 2013

Why America’s economy is recovering and Europe’s isn’t

The reason Europe’s economy isn’t recovering is a dogged insistence on austerity. That is the conclusion of John Cassidy, writing in the New Yorker:
The big mystery isn’t why austerity has failed to work as advertised: anybody familiar with the concept of “aggregate demand” could explain that one. It is why an area with a population of more than three hundred million has stuck with a policy prescription that was discredited in the nineteen-twenties and thirties. The stock answer, which is that austerity is necessary to preserve the euro, doesn’t hold up. At this stage, austerity is the biggest threat to the euro. If the recession lasts for very much longer, political unrest is sure to mount, and the currency zone could well break up.
So why is this woebegone approach proving so sticky? Some of the answers can be found in a timely and suitably irreverent new book by Mark Blyth, a professor of political economy at Brown: “Austerity: The History of a Dangerous Idea.” Adopting a tone that is by turns bemused and outraged, Blyth traces the intellectual and political roots of austerity back to the Enlightenment, and the works of John Locke, David Hume, and Adam Smith. But he also provides a sharp analysis of Europe’s current predicament, explaining how an unholy alliance of financiers, central bankers, and German politicians foisted a draconian and unworkable policy on an unsuspecting populace.
The central fact about Europe’s “debt crisis” is that it largely originated in the private sector rather than the public sector. In 2007, Blyth reminds us, the ratio of net public debt to G.D.P. was just twelve per cent in Ireland and twenty-six per cent in Spain. In some places, such as Greece and Italy, the ratios were considerably higher. Over all, though, the euro zone was modestly indebted. Then came the financial crisis and the fateful decision to rescue many of the continent’s creaking banks, which had lent heavily into property bubbles and other speculative schemes. In Ireland, Spain, and other countries, bad bank debts were shifted onto the public sector’s balance sheet, which suddenly looked a lot less robust. But rather than recognizing the looming sovereign-debt crisis for what it was—an artifact of the speculative boom and bust in the financial sector—policymakers and commentators put the blame on public-sector profligacy.
“The result of all this opportunistic rebranding was the greatest bait-and-switch operation in modern history,” Blyth writes. “What were essentially private-sector debt problems were rechristened as ‘the Debt’ generated by ‘out-of-control’ public spending.”
In other words, austerians are playing a game of ‘blame the victims’ and the consequences for real people’s lives are disastrous.

1 comment:

  1. Comment from Bill le Breton:

    The idea that Austerity is Dangerous Idea is a Dangerous Idea.

    It is a fallacy that America is recovering more quickly than Europe because Europe has had more austerity than the US. Austerity in the US has more than matched that of Europe.

    For a comparison of government spending in the US and Europe, see here:

    For a comparison of government spending as a percentage of GDP, see here:

    The big difference is that Europe has run a much tighter monetary policy than the US.

    It is possible that the dangerous thing about a policy of austerity is its damage to confidence and its reinforcement of the expectations that are discouraging investment and funding for investment. And therefore that, given the commentariat’s belief that ‘austerity’ is the problem, some easing/infrastructure spending or whatever is required.

    But whilst a central bank is following an inflation target, any boost to aggregate demand by new government spending will offset the tightening of monetary policy by that central bank – and/or the expectation by investors that this will occur. So any easing for psychological purposes MUST be accompanied by a change in the target given to the central bank.

    It is actually possible, as the US in 2013 has demonstrated that monetary easing is capable of offsetting fiscal consolidation and further easing still would great growth in both nominal and real GDP – which of course is the key to reducing the deficit (from increased tax on the increased earnings) and improving the debt:GDP ratio.

    When this whole period is reviewed by a future generation, it may be that it is not the economic liberals’ commitment to austerity that is so puzzling (they would, wouldn’t they?) but social liberals’ inability to grasp the importance of monetary policy and the power of monetary policy operating under the direction of inflation targets to offset fiscal stimulus.


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