Austerity at a time of economic contraction

Published on April 3, 2013 by Paul Alapat

With Greece, Portugal, Spain, Ireland, and Italy mired in recession, and many having contracted for several years, the European obsession with slashing public spending and managing national debt immediately appears suicidal.

The emphasis on fiscal discipline is essential for stable and sustainable economic growth over the long term, particularly in the face of aging demographics in most of Europe. However, the German insistence on fiscal austerity in the short term as a means to lower yields and fortify investor confidence is misguided.

The insistence on domestic belt-tightening in Continental Europe, echoed in the US and the UK, in the absence of significant external sources of aggregate demand growth, raises the risk that several of the recessions will tip into depressions, and that incipient recovery, including that in the US, could be cut short.

Unfortunately, political compulsions seem to be driving economic policy making in the EU, just as they did when the common-currency bloc was created. We may have to wait for the social fabric in PIIGS to unravel before a course correction in economic policies is allowed.

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