The austerity question: ‘How’ is as important as ‘how much’
Alberto Alesina, Francesco Giavazzi03 April 2012
Europe’s embrace of austerity has sparked a debate among economists. This column argues that the debate has gone astray. Until the critical principle – ‘how’ is as important as ‘how much’ – is embraced, the austerity debate in Europe will continue to be completely out of line with the real economic trade-offs.
The European debate on fiscal austerity has gone astray – focusing exclusively on the size of deficit reductions. What policy makers should really be focusing on is the budget tightening’s composition (tax versus spending) and on the accompanying policies. Indeed, the title of this Vox debate – “Has austerity gone too far?” – reflects this inappropriate emphasis on size.
In our view, the essential question is not 'how far' governments go but of 'how' they go far enough.
With crisis plaguing the Eurozone and austerity the favoured prescription for diseased EZ economies, some are asking: Can big fiscal consolidations, especially those based on cuts, actually restart growth? CEPR DP8658 examines four episodes of past fiscal consolidations in European countries and evaluates the evidence.
Many analysts blame Germany’s fiscal prudence for worsening the crisis. This essay argues that the monomaniacal focus on aggregate demand is based on slightly outdated and oversimplified Keynesianism. The real constraint on European growth is not Germany’s fiscal policy. It is the supply side rigidities that plague all European nations – especially those at the heart of this crisis. The demand side matters, but is it foolish to think that German budget deficit of 5% instead of 3% of GDP would solve Europe’s problems.
A widely held view in Europe goes more or less as follows. After the shock of reunification, Germany has sought to enhance competitiveness through a variety of means. The policy was remarkably successful, turning the “sick man of Europe” into a highly competitive economy. One implication, however, was an imbalance with the rest of Europe. Germany’s current account surplus find its counterparts in, amongst other places, current account deficits in southern Europe, especially Spain, Portugal, and Greece.