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News Post: Is Austerity the Answer Europe’s Been Looking For?

Since the collapse of the world markets, Europe has been obsessed with austerity.  Just recently, 25 of 27 EU member states agreed to a new “fiscal compact” that would never allow them to have a cyclically adjusted budget deficit of more than 0.5% GDP.  As the American economy has begun to heal, Europe’s austerity policies have drawn the scrutiny of economists from around the world.  Some see the measures as an impediment to global economic recovery; others see the efforts as a worthy, albeit frustrating, strategy for long-term stability and growth.  Considering the depth of the crisis, the ultimate verdict on European austerity will be out for years to come.

When Prime Minister Cameron took power, Britain “was supposed to be a showcase for ‘expansionary austerity.’”  Those skeptical of Cameron’s strategy, which has been adopted by a majority of EU nations, point to Britain’s paltry recovery in comparison to that from the Great Depression as a sign that austerity has effectively failed.  Four years into the Great Depression, Britain had regained its peak in GDP.  In comparison, at the same point in its current recovery, Britain is “nowhere close to regaining its lost ground.”  Such comparisons are not unique to Britain, as Italy and Spain are experiencing similarly frustrating recoveries in comparison to the 1930s.  Nonetheless, European leaders continue to beat the drums of austerity as the best option for recovery.

Austerity protesters in Brussels (AP Photo/Geert Vanden Wijngaert)

Those supporting Europe’s austerity measures recognize the short-term perils of a reduction in expenditures.  The argument goes, whatever short-run impact lower demand will have on Europe’s debt ratio will be offset by rebounds in future demand.  In the long-run, therefore, austerity’s impact on deficits, as opposed to debt ratios, will spur even greater economic growth.  Proponents suggest that prospective buyers of long-term European bonds would be wise to maintain confidence in austerity’s positive influence on deficits, not on the short-term negative impact it has on debt ratios, as a sign of long-term economic health.   In the end, cutting deficits will allow European countries to take on more risk in the future, increasing potential for growth.  Europe need only survive the short-term pains of austerity to reap its long-term rewards.

A glance at recent headlines would suggest Europe’s economy has only two options: austerity or stimulus.  Some suggest, however, that the answers to Europe’s crisis may not be so polarized.  Although stimulus may provide a shot of confidence to the system, the long term deficit impacts could impede future growth. Alternatively, austerity could forever stunt the development of a whole generation of European workers and consumers.  Many economists believe the true answer to Europe’s economic woes resides in neither camp, but rather in a more stable fiscal union of European states.  Former ECB president Jean-Claude Trichet envisioned the creation of a euro-zone Ministry of Finance to oversee national budgets and economic policies.  In order for such a system to succeed, members of the euro zone must commit themselves to developing more consistent and universal labor costs, levels of productivity, and financial systems for example.  Given the EU’s unity struggles over the last several decades, this will certainly be no small task.

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