Eurozone recovery: there are no shortcuts
Roberto Perotti 13 September 2014
There is a growing consensus that austerity is contributing to the Eurozone’s macroeconomic malaise, but also that spending cuts are needed in the long run to achieve fiscal sustainability. Some commentators have advocated a temporary tax cut financed by unsterilised ECB purchases of long-term public debt, accompanied by a commitment to future spending cuts. This column argues that such commitments are simply not credible – especially given the moral hazard problem created by central bank monetisation of debts.
The consensus is increasing that austerity has not worked – Europe stands on the edge of deflation and suffers from a deficit of demand. A recent VoxEU proposal (Giavazzi and Tabellini 2014) offers a solution that is widely shared on both sides of the Atlantic – all Eurozone countries should cut taxes simultaneously by 5% of GDP, and the ECB should buy the extra debt without sterilisation. This should be accompanied by a credible plan to reduce government spending in the future.
Macroeconomic policy Monetary policy
austerity, eurozone, monetary policy, helicopter money, quantitative easing, QE, stimulus, fiscal consolidation, fiscal policy, spending cuts, fiscal sustainability, debt monetisation
Revisiting the pain in Spain
Paul De Grauwe 07 July 2014
There has been a stark contrast between the experiences of Spain and the UK since the Global Crisis. This column argues that although the ECB’s Outright Monetary Transactions policy has been instrumental in reducing Spanish government bond yields, it has not made the Spanish fiscal position sustainable. Although the UK has implemented less austerity than Spain since the start of the crisis, a large currency depreciation has helped to reduce its debt-to-GDP ratio
The different macroeconomic adjustment dynamics in Spain – a member of a monetary union – and the UK – a stand-alone country – is stark. Paul Krugman popularised this contrast in his New York Times blog with the title “The Pain in Spain” (Krugman 2009, 2011), and commented on my own analysis in De Grauwe (2011).
Europe's nations and regions Global crisis Macroeconomic policy
ECB, monetary policy, euro, EMU, Spain, monetary union, fiscal policy, UK, government debt, austerity, EZ crisis, Outright Monetary Transactions, currency depreciation
The social impact of fiscal policy responses to crises
Carlos A. Vegh , Guillermo Vuletin 12 June 2014
The question of whether fiscal policy should be pro- or countercyclical has become increasingly relevant during the recession. This column provides causal evidence from South American countries showing the success of countercyclical policy in improving social indicators of economic success, combined with correlative evidence from Europe. This represents a strike against the case for austerity-led growth.
Fiscal policy in many developing countries is typically procyclical. Expansionary in good times and contractionary in bad times, these policies often amplify business cycles. The most convincing explanations for such practices seem to be limited access to international credit markets during bad times and political pressures that tend to encourage too much public spending during boom periods (Calderon and Schmidt-Hebbel 2008). Whatever the reason, the pattern is well documented (see Frankel, Vegh, and Vuletin 2011 on the spending side and Vegh and Vuletin 2013a on the tax side).
fiscal policy, business cycle, austerity, cyclicality, LAC-7
Fiscal adjustment and growth: Beware of the credit constraints
Emanuele Baldacci, Sanjeev Gupta, Carlos Mulas-Granados 31 March 2014
The recent debate on the link between austerity and growth has focused on the short run. This column discusses recent research into the link between fiscal consolidation and medium-term growth under different financial conditions. If credit is not available to consumers and investors, private demand is less able to compensate for cutbacks in public demand, so large spending cuts can have a negative effect on growth. Difficult financial conditions probably explain why fiscal adjustments that worked in the 1990s have not produced similar beneficial effects on growth in recent years.
In the aftermath of the recent financial crisis, the discussion of the effects of fiscal adjustment on economic growth has intensified. While some scholars have focused on the characteristics of the fiscal consolidation needed to bring public debt down from historically high levels, others have examined the effects of alternative strategies on economic performance. The VoxEU debate aptly covered in “Has Austerity Gone Too Far?” (Corsetti 2012) sums up the conflicting positions.
Financial markets Macroeconomic policy
financial crisis, fiscal policy, deleveraging, fiscal consolidation, debt, credit constraints, austerity
Tax evasion and austerity-plan failure
Francesco Pappadà, Yanos Zylberberg 03 February 2014
Greece’s austerity package included an unprecedented increase in the VAT rate, but the resulting increase in revenue was much lower than expected. This column links this disappointing result to the ‘transparency response’ of firms to higher tax rates. In countries like Greece with poor tax monitoring, firms face a tradeoff when deciding whether to declare their activity. Transparency is a necessary condition for accessing external finance, but it also means having to pay tax. Improving credit conditions for small and medium-size Greek firms might shift this tradeoff in favour of transparency.
Austerity plans in southern European countries (Greece, Portugal, Spain, and Italy) have so far yielded mixed results (Salto 2013). On the one hand, the primary budget balances of these countries have improved, and their risk premiums are now stabilised at a much lower level than during the crisis peak.
Financial markets Taxation
VAT, transparency, tax evasion, Greece, credit, austerity, European sovereign debt crisis
Public debt and economic growth: There is no ‘tipping point’
Markus Eberhardt, Andrea F Presbitero 17 November 2013
The idea that there is a common tipping point in the relationship between public debt and economic growth is still widespread. However, this is likely due to a misinterpretation of the existing evidence. Once we allow for the relationship between debt and growth to be country-specific, there is limited evidence supporting the presence of a within-countries debt threshold.
The presence of a common threshold, or ‘tipping point’ – beyond which the detrimental impact of debt on growth is significant, or significantly increases – is currently taken as given in many policy circles. In the US, although many political battles impinge on the Congressional debate over the debt ceiling and the resulting government shutdown of October 2013, this somewhat reflected a widespread belief that debt is dangerous, and that fiscal austerity represents the only way of restoring sustainable growth.
growth, debt, austerity
Pushing on a string: US monetary policy is less powerful during recessions
Silvana Tenreyro, Gregory Thwaites 12 November 2013
Governments wary of fiscal expansion have turned to monetary policy to stimulate slowly recovering economies. This column presents evidence that lowering interest rates is ineffective during recessions – just when fiscal policy would be most effective. If this result is robust, we are seeing recent signs of recovery in spite of austerity, not because of it.
Most industrialised countries have been trying to cut public borrowing without impeding recovery from the Great Recession. Central banks have attempted to square this circle by loosening monetary policy. For example, UK finance minister George Osborne has stated that “theory and evidence suggest that tight fiscal policy and loose monetary policy is the right macroeconomic mix” for countries with excessive private and public debt (Mansion House speech 2012).
Global crisis Monetary policy
monetary and fiscal policy, economic recovery, US, austerity
Austerity and stupidity
Lorenzo Bini Smaghi 06 November 2013
Today’s austerity, many argue, is stupid. This column argues that today’s EZ austerity may arise from stupidity before the crisis – specifically lacklustre structural reform. Excess debt arose in nations maintaining unsustainable living standards and welfare systems in the face of poor growth. The Crisis forced radical adjustments such as austerity in a recession. It’s not austerity which caused low growth, but low pre-Crisis growth which ultimately caused austerity. The way out of austerity is fundamental pro-growth reforms that create room for more gradual fiscal adjustment.
The recent Eurozone crisis has shown that austerity measures are self-defeating. They produce severe recessionary consequences which – at least in the short term – tend to increase public debt, as a ratio to GDP. This assessment is confirmed by econometric analysis showing that budgetary adjustments have been more recessionary than expected, with fiscal multipliers being higher than unity (Blanchard and Leigh 2013).
How to make Europe's incipient recovery durable – A rejoinder
Marco Buti, Pier Carlo Padoan 08 October 2013
The causes of the Eurozone’s slow growth are much debated. This column argues that fiscal consolidation will be less of a drag going forward but that the ongoing recovery remains fragile. A policy strategy is needed to support the recovery based on three mutually reinforcing elements – reducing policy uncertainty, repairing the financial system, and undertaking structural reforms.
Our recent Vox column triggered an interesting and lively debate (see for instance Krugman, 2013; Fatas, 2013; Watt, 2013). In it, we argued that weak private investment is partly to blame for the growth shortfall of the Eurozone compared to the US in the past few years and that putting in place conditions for stronger investment was essential to turn the recent pick up of confidence and activity in the Eurozone into a robust and self-sustained recovery (Buti and Padoan, 2013).
Great Recession, austerity, EZ recovery