Why austerity policies may not work in the Eurozone

If you wish to see a true austerity policy then look at Greece. They have had major cuts in public spending, major cash reductions in wages and salaries, major job losses, and mass unemployment. It just seems to go with being in the Euro

Austerity and the euro
Sir John Redwood MP
On 2 March 2015 08:50

The Eurozone’s disciplines have been nicknamed the politics of austerity for good reason. Each state is meant to keep its budget deficit down to 3 percent of GDP – way below the large cyclical deficits the UK, US and other single currency areas allowed themselves in the great recession.

Each state is meant to keep its total amount of borrowing to below 60 percent, though most of them have given up on that idea. No individual state can print more money, make its economy more liquid or devalue to provide a private sector stimulus.

As a result when a Eurozone state cuts public spending it is likely to lead to a fall in GDP which the private sector struggles to offset or does not offset at all.

We have seen that cutting the growth rate of public spending substantially in the UK after 2010, and in the US cutting national defence spending and State level spending, did not lead to a fall in GDP. The private sector responded well to extra money being put into the system, to the gradual rebuilding of the banks and the spread of some more private credit, and to the available spare resources caused by the great recession.

Both countries experienced a recovery despite or because of the action taken to control public sector budgets. Both benefitted from the continued low interest rates, made possible in part by growing control of state borrowing. In the UK real public spending did edge up a little as well.

I was criticised recently for quoting deficit reduction as a percentage of GDP rather than in cash terms. As I have often pointed out, the fall was bigger as a percentage of GDP, smaller in cash terms. I used this version on Thursday because I was dealing with those who said budget cuts would lead to another recession, and they always use the figures which show the biggest “cuts”

In contrast, the much harsher budget cuts in Greece have added to the collapse in GDP in that country. Greece today has a national income and output 22 percent below its peak in 2007. It is amazing that the policies which have created this disaster have been allowed to continue for so long.

Even now that the Greeks have voted in a government which rightly points out how damaging the policies have been, there cannot be much change as that same government bizarrely wishes to stay in the Euro, the origin of much of their trouble.

The enormous Greek recession has gravely reduced tax revenues. As a result there have to be most severe cuts in public spending to try to get the deficit down to the tough target levels -- in Greece’s case even tougher owing to the debt covenants.

The private sector so far has been unable to pick up the very considerable slack. owing to weak banks. Greece has no power to create more money, no power to lower its own interest rates further, no power to devalue to price itself back into more world markets.

As a result they have experienced the misery of sliding from public sector cuts to less private sector demand, and from less tax revenue to more public sector cuts.

If you wish to see a true austerity policy then look at Greece. They have had major cuts in public spending, major cash reductions in wages and salaries, major job losses, and mass unemployment. Many businesses have closed. Any sensible person is against the kind of austerity policy inflicted on the Greek people. Unfortunately it just seems to go with being in the Euro.

Mr. Redwood's writing is re-posted here by his kind permission. This and other articles are available at  johnredwoodsdiary.com

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