In the age of stalled growth, crippling unemployment, near-deflation, and extremely poor recovery prospects, the policy-makers of this world have been enslaved by an idea that fiscal contraction can help the economy expand. The legends of expansionary austerity, like the toxicating songs of mythological sirens, have clouded the judgments of both academics and practitioners. Many of us believed that budget conservatism amidst the greatest recession since the 1930s could actually stimulate aggregate demand. Fortunately, it didn’t take too many years for us to realize that fiscal consolidation not only doesn’t stimulate growth, but it hinders an economy’s chances of rebounding out of the slump, putting an unnecessary obstacle on taxpayers to survive the cuts on the social welfare programs.
It all started with the distinguished research paper by Alberto Alesina and Silvia Ardagna, which suggested that austerity can be expansionary. The paper was controversial the day after it was published, is put under question yet again. There really has been quite an astonishing obsession among academic and policy economists that a fiscal contraction could lead us out of this recession. Recession is the key word here. Again, the basic idea was that austerity would calm down the markets by raising institutional credibility, bring down the interest rates, and eventually act as a stimulus to investment and thus growth overall. A small nuance, however, is that this could have never worked in principle or in practice when the economy is already in a deep recession. In normal times, stabilizing the budget is nothing but logical and indeed the right thing to do. But in these extraordinary circumstances, further downward pressure on growth is a dead-end game which, unfortunately, policy-makers particularly in select European countries decided to play. Much to the general public's frustration and unnecessary suffering.
So, what is the state of affairs today? We have been seeing a gradual decline in the unemployment rate in the US, all the while the government stimulus to revive the economy has remained active. Consumer debt has declined, suggesting that households are gradually beginning to offload debts off their shoulders and start to spend the economy out of a slump. As it turns out (shockingly) - contractionary policy will contract the already recessing economy, and expansionary policy will literally "expand" the aggregated output, with a time lag, naturally.
This is all in perfect parallel with what standard macroeconomic theory would predict: a collapse in aggregate demand met with aggressive (not aggressive enough, in my opinion) fiscal and monetary responses which alleviate the impact of a massive household deleveraging shock and a collapse of trust in the financial system, with the lag of the policy impact being especially long because of the severity and magnitude of this particular crisis.
Now, as the stimuli have gone into effect and consumers finish to repay the outstanding debt obligations, the economy is on a slow, but nevertheless steady rise as supported by falling unemployment. Consider the evidence below for the graphs of US unemployment, public debt, and household debt:
Source: FRED Blue line: Unemployment Red Line: Household Debt Outstanding Blue Line: Total Public Debt |
Meanwhile in Europe, while the disillusioned policy-makers in Brussels are sticking to the old agenda of expansionary austerity... oh, wait:
Adherence to fiscal discipline is a necessary condition for growth,” Mario Monti told an audience at the London Stock Exchange on January 18th. “It is not however a sufficient condition.” His message to Mrs Merkel and Mr Sarkozy is that the EU must move from reliance only on austerity towards some growth-stimulating measures.
Mario Monti, newly established Prime Minister of Italy, ex-president of Bocconi University, the school which granted me my Bachelor in International economics, is suggesting that although fiscal responsibility is very important, austerity by itself is not at all sufficient to recovery or growth; especially in our current conditions. This is something we, and me, concluded months if not years ago.
The European austerity project is obviously failing. The continent is facing a real threat of a decade of stagnation, low growth, weak domestic demand, poor innovation and technology perspectives, and yes - even potentially dangerous political consolidations, as already witnessed in the struggling Hungary.
Europe needs growth. The US has demonstrated that even with an inadequately packaged fiscal stimulus and an above-average monetary response, the country managed to escape a double-digit unemployment figure, unlike the Euro Area for which the number currently stands at the record-breaking 10.3%.
Facts are on the table. But until the poison of expansionary austerity fades away, suffering will continue.
* Rustam Jamilov
From Baku, Azerbaijan
Junior Economist at the Central Bank of the Republic of Azerbaijan
Lecturer at Azerbaijan State Economic University
Alumnus of CEU Business School
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