Monday, April 29, 2013

End of Austerity

The debate about austerity is getting much clearer now. There are increasing signals that austerity led policies have reached political limits in the face of growing opposition in countries hit by the recession. As economic pessimism  deepens over the global economy, the IMF called for more economic stimulus after revising downward its growth forecasts.

As Krugman points out, the austerity ideology has imploded. Academics who supported austerity are now in the defensive.  C. Reinhart and K. Rogoff  argued in a recent paper  that high public debt , exceeding 90% of GDP hinders economic growth. This has been criticised by many economists and also the IMF recently on the basis of non conclusive evidence. But the question is to ask why the level of public debt rose dramatically in recent years. There were no wars nor fiscal lax  in booming economies. Spain and Ireland had sound public finances, with primary surpluses just before the financial crisis.

The other argument which prevailed in the economic debate is 'expansionary fiscal austerity' put forward by Alesina and Ardegna. The basic idea is that fiscal consolidation may boost short term growth. here again, the IMF opposes this argument, arguing that a  fiscal consolidation equivalent to 1% of GDP leads on average to a 0.5% decline in GDP after two years, and to an increase of 0.3 percentage points in the unemployment rate. Spending cuts may also be associated with declines in interest rates which help alleviate the impact on the real economy. Success stories of economic recovery like Latvia or Ireland are more ideological than actual. Just look at Ireland and Spain- the real economy has not recovered and unemployment rate continues to soar dangerously.

So why austerity has been so influential in the economic policies? Again, Krugman argues that austerity is the 1% doctrine, meaning that the dominant classes are marginally affected by spending cuts (rather than tax rises) unlike mliddle-classes which see their purchasing power much reduced. This further increases income inequality and depresses internal demand, thereby aggravating the recession. the austerity ideology has also been nurtured by moral arguments. The 'parable of excess' reflects the idea that one cannot spend more than its earnings and this generates debt that cannot be repayed. Sinful people are those who contract debt, but are they responsible for mass unemployment?

Central banks have exhausted their possibilities of intervention in terms of monetaryt stimulus. Now it is up to the governments to find a solution to the crisis. It is not enough the change the narrative, but to act effectively in support of jobs and redistributing wealth. If they fail, democracy will pay a high price. 

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