Output effects of fiscal consolidations

Carlo Favero, Francesco Giavazzi 07 September 2012

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The austerity debate turns on a central economic logic – how does fiscal policy affect output? This is a tricky question since declining output can affect fiscal policy just as much as fiscal policy can affect growth. Governments, after all, don’t make policy in a vacuum.

The key to estimating the effects of fiscal policy on output is this identifying shifts in fiscal policy that are 'exogenous'. Policy changes that are not a response to the state of output – as would be the case, for instance, of a fiscal expansion induced by a fall in output.

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Topics:  Global crisis Macroeconomic policy

Tags:  fiscal policy, fiscal crises, austerity

Fiscal consolidation and reforms: Substitutes, not complements

Coen Teulings 13 September 2012

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Many OECD countries suffer from high sovereign debts. Sooner or later, this problem must be addressed. That will require some form of fiscal retrenchment.

Quite often the fiscal problems are due to market rigidities, barriers to entry, and distortive tax systems. A programme of reform must therefore include both fiscal consolidation and institutional reform to enhance future growth. Growth and the larger tax base that goes with it provides the best prospect for solving the fiscal problems.

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Topics:  Macroeconomic policy Taxation

Tags:  Institutional reform, fiscal crises, Fiscal retrenchment, austerity

The impact of alternative paths of fiscal consolidation on output and employment in the UK

Nitika Bagaria, Dawn Holland, Jonathan Portes, John Van Reenen 14 August 2012

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In 2009-2010, the UK's budget deficit was about 11% of GDP (see here); there was no dispute among economists that a credible plan for fiscal consolidation was required. The discussion turned on the timing, given the fact that short-term interest rates are effectively at zero, output is substantially below capacity, and unemployment well above most estimates of the natural rate of unemployment.

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Topics:  Global crisis Macroeconomic policy Taxation

Tags:  fiscal policy, UK, global crisis, Fiscal crisis, austerity, consolidation

The Procyclicalists: Fiscal austerity vs. stimulus

Jeffrey Frankel 07 August 2012

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The world is seized by a debate between fiscal austerity and fiscal stimulus. Opponents of austerity worry about contractionary effects on the economy. Opponents of stimulus worry about indebtedness and moral hazard (see Corsetti 2012).

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Topics:  Macroeconomic policy

Tags:  fiscal stimulus, austerity, countercyclical fiscal policy

Austerity is unavoidable after a bout of profligacy

Daniel Gros 19 July 2012

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Austerity is killing growth in Europe! This narrative is now firmly established among many influential economists and policymakers (Layard 2012). The data do not support this view – at least if one takes a medium-term view.

Since the end of the bubble in 2007, the economic performance of the US has been very similar to that of the Eurozone, although the US has used a much larger dose of fiscal expansion.

As shown in the figure below, the US and the Eurozone have actually followed a very similar pattern:

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Topics:  Macroeconomic policy

Tags:  fiscal policy, austerity

The tragic error of excessive austerity

Richard Layard interviewed by Viv Davies,

Date Published

Fri, 07/06/2012

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Transcript

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Viv Davies:  Hello, and welcome to Vox Talks, a series of audio interviews with leading economists from around the world. I'm Viv Davies from the Centre for Economic Policy Research. It's the 5th of July, 2012, and I'm speaking with Professor Lord Richard Layard, founder and emeritus professor of the Centre for Economic Performance at the London School of Economics. We discuss his recently published Manifesto for Sound Economics, written with Paul Krugman, which aims to generate a movement of economists who are prepared to speak out against policies they know to be wrong.

Professor Layard briefly summarises the manifesto and what he considers to be the errors that have taken root in public consciousness and which have provided support for the excessive austerity of current fiscal policies in many countries.

We also discuss the role of the European Central Bank as a lender of last resort, and whether the current bank-led capitalist culture will ever be changed. I began the interview by asking Lord Layard to summarise why he thought the manifesto needed to be written.

Richard Layard:  Well, I think the majority of economists probably disagree with what is presently going on, and in particular with the assertion that the only way to get growth is to take extra action to reduce public deficits. That, of course, is getting things the wrong way round, because the deficits are not because of low growth; it's the low growth that's the cause of the deficits. We have these deficits, but not because there was irresponsible public borrowing back in 2007, because there was excessive private borrowing and lending, which led to the bust, which lead to reduced private spending. Then the reduced private spending led to reduced tax receipts, and so the lower taxes which are causing the deficits in the public finances.

So when you've got a reduction in private spending, the last thing you want to have is simultaneously a reduction in public spending, thereby cutting the total level of activity in the economy. And you don't want to have, equally, big tax rises reducing private spending.

And what is remarkable is that there is no evidence that doing these things ‑‑ which every country is being told they have to do ‑‑ will produce the growth which people assert is going to be the result. So the IMF in its latest economic outlook has a wonderful chapter where they look at 183 episodes in the past where countries have taken discretionary action to reduce their deficits, and they show that in the vast majority of cases, this led not to faster growth but to slower growth, which is what, of course, the ordinary economics textbook for a depression economy would lead you to expect.

There's another issue. If we slow growth in this way, we're having a bad effect on the future path of deficits. We're going to have higher deficits further into the future, and there's a strong argument put forward by Larry Sumners and Brad DeLong in Brookings papers that if you increase the deficit in the short run, this would have the effect of stopping unemployment becoming endemic, and thereby making it easier to have higher growth in the medium term, and therefore lower deficits in the medium term, which would more than offset the slightly higher deficits you have in the short term.

So, really, just to go on trying to cut deficits in the short term is a very counterproductive policy.

Viv:  The manifesto presents two counterarguments to your proposal. A confidence argument in that austerity increases confidence and the prospects of recovery, et cetera, and a structural argument against expanding demand in that output is constrained on the supply side by structural imbalances in the economy. Could you elaborate a little on these arguments and how you counter them in the manifesto?

Richard:  Well, the confidence argument says that if you increase the deficit, this will raise interest rates, and that will produce lower growth. There really isn't any evidence of that in the conditions we're now in. We would have significantly higher interest rates if we had a higher deficit. Because just look around. You see absolutely massive deficits in the US, Britain and Japan, and you see almost the lowest interest rates that we've ever seen. So it's just not a reasonable spectre to be raising. In fact, the confidence argument is obviously failing, because you can see that businesses are not feeling confident because of the deficit reduction policies. They're feeling, "Oh my god, where is the demand going to come from?"

This deficit reduction policy is just going to impose low growth on our countries for some years. We're not going to invest because we can't see the market. So the confidence argument isn't working. The structural argument is also invalid, because suppose that we were being inhibited from expanding aggregate demand because there were some sectors that were already operating at full capacity.

Then we would have to see some sectors operating at full capacity. We don't see that, we see in most the countries, we see excess capacity and unemployment in every part of the economy, and higher unemployment in every occupation.

It's not a plausible argument, the structural one. It was used during the Great Depression, and lo and behold when people said the American economy can't produce any more, suddenly there was the Japanese threat and from 1940 to 1942 the US GDP rose by 20%. It had been limited by demand rather than by supply.

Viv:  Within a European context, would you be in favour of the ECB acting as lender of last resort to European banks?

Richard:  Well, the European problem is a different one. I perhaps should have referred to it when we were talking about interest rates, because of course European interest rates in many countries are very high. But this is not because these countries were irresponsible in their budgetary policy in 2007. We had falling debt income ratios in Spain and Italy and some other countries in 2007. Even now, Spain and Italy have lower deficits than the US, Britain and Japan, even though they also have higher interest rates.

It's just not the case that the interest rates are caused by those deficits so much as the fact that the countries of Spain and Italy do not have a central bank behind them that will fund their deficits, whereas Britain, Japan and the States do have a central bank behind them that would in the last resort fund these deficits.

So we have to have institutional reform in Europe, and we have to have some system whereby ultimately the central bank will not only be a lender of last resort to European banks but also a funder of governments on certain conditions, of course, and that's why we have to have these much more strict arrangements for European supervision of budget deficits in the different member countries.

Viv:  So it's clear then that the global financial crisis wasn't a blip on the landscape, but what you're advocating calls for a radical and very significant cultural and political shift. Do you think banks, businesses and governments are ready and prepared to go that far? Will they ever be?

Richard:  Well, I think the public is going to demand it. And I think there are sort of very specific reasons relating to this crisis which are going to lead to much greater regulation of banks, and hopefully more government activism in getting us out of the recession. But I also think actually that there will be and needs to be a big cultural change in a different capacity. I've been a co‑founder of something called "Action for Happiness," which is a movement to encourage people, in fact all the members pledge to try to create more happiness in the world and less misery. To lead a moral life in everything they're doing, including their work life.

And I don't think we want people working in businesses unless they think that what they're doing is socially useful. I think we've got to get back to that kind of concept of a life that is dedicated to the common good in some way or other, and not simply dependent on self‑interest.

Viv:  So finally, how would you like to see economists respond to your manifesto?

Richard:  Well, I want everybody to get up and shout and write articles, send off letters, organise meetings and make sure that we stop proceeding in this way, which is bringing in so much misery to our people.

Viv:  Lord Layard, thanks very much for taking the time to talk to us today.

 

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Topics

Global crisis
Tags
ECB, fiscal policy, austerity

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Has austerity gone too far? The Manifesto for Economic Sense
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Richard Layard explains the Manifesto for Economic Sense

Richard Layard 28 June 2012

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You may have seen the "Manifesto for Economic Sense" which Paul Krugman and I are promoting.1 Our aim is to generate a movement of economists who speak out against policies they know to be wrong. In the end, as we know, it is ideas that rule, and I have been shocked by the ideas that now rule, even inside the heads of my tennis friends.

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Topics:  Macroeconomic policy Politics and economics

Tags:  fiscal policy, austerity, Manifesto for Economic Sense

Rethinking austerity: Introducing a new Vox eCollection

Giancarlo Corsetti 23 June 2012

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Even as the first Vox eCollection is going online, the global economy is being shaken by events ranging from a Chinese economic slowdown to the possibility of a delayed Greek Eurozone exit. The fact that such events can be viewed as dangerous for the world economy as a whole is a powerful testimony to how profoundly fragile are macroeconomies and financial sectors in the mature economies – four and half years after the eruption of the global crisis.

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Topics:  Macroeconomic policy

Tags:  fiscal crises, austerity

Austerity: Too Much of a Good Thing?

Giancarlo Corsetti,

Date Published

Sat, 06/23/2012

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http://www.voxeu.org/index.php?q=node/8121

 

Austerity: Too Much of a Good Thing? 

edited by Giancarlo Corsetti

Published 14 June 2012

Download the PDF of the eBook here.

Tags
Greece, Eurozone crisis, austerity, Vox eCollection; Vox Debates

The impossible hope of an end to austerity

Charles Wyplosz 14 May 2012

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Thanks to French and Greek voters, austerity is finally being debated seriously. Until now, the debate was circumscribed to economists, with the usual Keynesian and anti-Keynesian chapels trading theoretical and empirical arguments over the size and the sign of the multipliers.1 As usual, any prejudice can be buttressed with some research.

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Topics:  EU policies Europe's nations and regions Macroeconomic policy

Tags:  government spending, Eurozone crisis, austerity

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