The Greek Crisis: The impossible hope of an end to austerity

Monday, May 14, 2012

The impossible hope of an end to austerity

by Charles Wyplosz

Vox
May 14, 2012

With French and Greek voters rejecting austerity, politicians are once again taking the government spending debate seriously. This column argues that the voters are right – it is a bad idea to tighten fiscal policy when growth is so feeble. But the column adds that, wherever one looks, the road away from austerity looks desperately blocked.

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. As usual, any prejudice can be buttressed with some research.

It has now emerged that growth in Greece and elsewhere has been “disappointing” and that debt-to-GDP ratios do not decline much when growth is negative and deficits are “surprisingly resistant”. The problem is that even enthusiastic pro-growth economists will find it hard to come up with policy suggestions that can turn the situation around reasonably soon. Structural reforms are what are badly needed, but their effects are too slow for prompt relief.

Figure 1 shows the relationship between budget stabilisation efforts, measured on the horizontal axis as the change in the cyclically adjusted primary balance ratio to GDP, and the change in the actual budget balance ratio. The 45 degree line is the effort-equals-effect threshold – i.e. the austerity efforts (horizontal axis) are matched by actual improvement in the primary deficit to GDP ratio (vertical axis).

The squares correspond to those countries where real GDP overall growth over the period was less 2.5%; in these countries, with one exception (Hungary, which stabilised earlier) the outcome is worse than the effort.
The diamonds represents countries that grew faster; in these, the outcome was at least as good as the effort.

Plainly it is a bad idea to tighten fiscal policy where growth is feeble (or negative).

Figure 1. Budget balance effects of budget consolidation efforts