Fiscal austerity or economic growth?
Although it’s not officially on the agenda, that question will dominate the discussions this weekend as political leaders of the world’s largest economies assemble at Camp David.
Steven Pearlstein is a Pulitzer Prize-winning business and economics columnist at The Washington Post.
And that same question — how, how much and how quickly to cut the federal budget deficit — remains the central issue in this year’s U.S. presidential and congressional elections.
This is hardly a new debate; it’s been going on ever since John Maynard Keynes and Friedrich von Hayek sent dueling letters to the Times of London at the onset of the Great Depression. But it has lately taken on new urgency as attempts to rein in government budget deficits in Europe have sparked a backlash from voters, sent much of the continent back into recession and threatened the future of the euro.
The argument for belt-tightening austerity is that government debt in many countries has climbed so high that it threatens to create a vicious spiral: Higher interest rates beget recessions, which in turn lower government tax revenues and lead lenders to demand even higher interest rates. The inevitable result is default and depression.
The rapid rise of interest rates for the bonds of Greece, Ireland, Portugal, Spain and Italy a year ago raised the specter of just such a debt spiral. European leaders responded by committing themselves to immediate and dramatic reduction in deficit levels. Similar fears have energized debt-cutting fervor in the United States.
Where the problem comes in is that too much austerity imposed too quickly risks causing another, similar downward spiral. In this deflationary spiral, overly aggressive tax increases and budget cuts lead to sharp increases in unemployment and decreases in spending and investment, causing tax revenues to fall so much that budget deficits actually go up. That’s certainly what has happened in Greece, Ireland and Portugal, and to a lesser degree in a number of other countries, including our own.
Given this choice between default and deep recession, what’s a highly indebted country to do? As Olivier Blanchard, the chief economist at the International Monetary Fund, observed, there is a “damned if you do, damned if you don’t” quality to the austerity debate, one that is often overlooked by dogmatic Keynesians who argue reflexively that the right course is always to borrow and spend to stimulate growth, and Keynesian skeptics who are equally reflexive in arguing that any positive effects of fiscal stimulus are more than offset by a loss of confidence by investors and business owners.
In truth, austerity vs. growth is a false choice. The right answer depends on the economic particulars — the relative efficiency of a country’s economy, the mood of the markets, what’s going on in other countries at that moment in time. It also depends on the particulars of the austerity or the stimulus — what spending is increased or decreased, what taxes are raised or lowered. Also important are what structural reforms are put in place to accompany the austerity or the stimulus.
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