Three austerities

15 Jun


Carnivore Austerity

The carnivores go for a strong version of the austerity thesis: if you cut spending and adopt structural reforms (make it easy to hire and fire folks, make it easy to set up a business or enter a profession) there is a good chance you can get growth and employment after some years of pain. For them, fiscal policy is in general a bad idea, whose effects wither out anyway because of the calculations of consumers and investors who figure out that fiscal stimulus means future taxes, making them cut consumption and investment in the middle of the crisis. Just stay the course and plug wax in your ears to screen off the cries of pain and the “you can’t end hunger through anorexia” slogan. When all is said and done people will eventually thank you for it. This argument is the most influential and is upheld by leading macroeconomists, the governments of large European countries and the ECB.

Vegetarian austerity

In contrast, the vegetarians are a little less sure about virtues of the austerity diet. Composed of an increasing part of macroeconomists and some policymakers, the vegetarians tend to sprinkle more doubts, footnotes and caveats on the virtues of austerity. In May 2012 even the hard-hearted Economist joined them. Nevertheless, they demand austerity and structural reforms for a different reason than the carnivores: they live in fear that bond market investors will ask for higher risk premia on sovereign bonds if states fail to reduce debt and deficits to levels that reassure bond investors that they will get their money back. This is the least bad option of the menu even if this means austerity in the short run.

Should all European countries let this fear guide policy decisions? The vegetarian answer is yes. All countries with high debt burdens face bad fiscal policy choices during periods of heightened risk aversion, irrespective of whether they still enjoy credibility with bond investors or not. Thus, austerity in highly indebted countries that can still borrow cheaply (Britain) is just another form of insurance policy against a costly bond market rebellion made possible by a volatile bond market. In highly indebted countries that are priced out of the bond market (Greece, Portugal), deficit-reducing austerity is the only choice if they want to ever borrow again.

Vegan austerity

Finally, enter the vegans. For them, there are two Europes and they have different choices on austerity. First, there is the Europe that can enjoy the taste of the buttery non-austerity diet at best and a slowdown in austerity at worst because they already have the confidence of the markets, low deficits and current account surpluses. These are the export-led economies of Germany, Austria, the Netherlands and Scandinavia. By contrast, the countries with low investor confidence (i.e. Southern Europe) should fast for another decade or so by cutting spending and adopting structural reforms, but the their cuts should be less savage and more staggered than those demanded by carnivores and vegetarians. The point is simple: you cant have austerity at the same time throughout Europe without an overkill in demand and a second recession bout. The Northern supervirtuous should spend more to compensate for the Southern Europeans forced into a monastic lifestyle.

The vegan critique is the most influential alternative. It’s the standard line in the FT, in the latest research done by the Summers and deLong and, more timidly, in some IMF research. Where does its hostility to the carnivore-vegetarian consensus come from? Well, say the vegans, in two years and a half of austerity, the countries that have tightened the GDP the most have had the largest drops in GDP. In Greece, for example, 8 percentage points of fiscal tightening cut the GDP by 12 percent. Modest tightening has been associated with modest growth. In short, small exercises in belt tightening lead to recessions and big exercises bring recessions (Wolf 2012). The fiscal contraction has a much more damaging effect on economic output when activity is depressed as it is now than it would do during a stronger stage of the business cycle. Fiscal austerity measures would reduce eurozone economic growth by one percentage point this year, according to Deutsche Bank. “That alone would not drive the eurozone into economic contraction, but we have a combination of fiscal austerity and a credit crunch. It is a self-inflicted recession – you don’t get the same combination of shocks elsewhere in the world.”

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