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The Fiscal Austerity Debate

Author: Roya Wolverson
June 8, 2010


As global financial markets continue to fret over gloomy economic news coming out of Europe and the United States, the dominant question is how long investors will tolerate high fiscal deficits among European and U.S. governments. And without fiscal stimulus, what policies can stave off a double-dip recession?

Investors' fears were not allayed (WSJ) by EU plans to monitor national budgets more closely and impose tougher sanctions on excessive budgets. Even more troubling are the differences brewing among global financial officials over the merits of continued government spending. At this weekend's meeting of G20 leaders in South Korea, the group reversed its previous stance (Reuters) from April that supported fiscal spending, stating in its latest communiqué: "Those countries with serious fiscal challenges need to accelerate the pace of consolidation. We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions."

By contrast, the message from Washington (NYT) was that tightening fiscal policy could impede growth and squelch the still fragile recovery. In the wake of a troubling U.S. jobs report, U.S. Treasury Secretary Timothy Geithner urged the G20 that, in the absence of strong U.S. consumer spending, global "fiscal consolidation should be 'growth-friendly'" and the severity and timing of budget cuts should vary across countries. But Geithner's warnings didn't go far. The White House's push for countries with large trade surpluses, like Germany and China, to continue to stimulate domestic demand was especially lost on Germany, which went on to announce (AP) fiscal austerity measures to slash fifteen thousand public-sector jobs on June 8. British Prime Minister David Cameron echoed the call for severe cuts in Britain.

The real question is whether jittery financial markets are distracting austerity-oriented governments from economic realities, says Paul Krugman in a recent blog post. Calls for severe austerity measures among the world's stronger economies reflect a "presumption that markets will turn on us unless we demonstrate a willingness to suffer, even though that suffering serves no purpose," he says. The Economist's Ryan Avent adds that the size of fiscal stimulus packages "means very little in the context of broader budget problems, and so cutting it hurts economies without doing much to improve the budget picture."

But others see continued fiscal spending against the backdrop of a widening sovereign debt crisis as short-sighted and politically driven. In the Financial Times, economist Jeffrey Sachs argues that while Keynesian-style stimulus measures have failed to jumpstart the economy, these policies have nevertheless endured because of "the perennial political attractiveness of tax cuts and spending increases." Politicians' mistaken focus on a green recovery funded by "shovel-ready" projects was bound to fail, he adds, because the shift to sustainable energy systems "could never be a short-term jobs program."

Still, draconian spending cuts are not the solution, argues Sachs. Instead, governments should focus on longer-term budget plans and structural reforms in sectors like higher education, because there are "no short-term miracles, only the threat of more bubbles if we pursue economic illusions."

More Analysis:

In the Times of London, the Hudson Institute's Irwin Stelzer says the market worries are "all reasonable, but all a bit overblown." The more likely outlook is for a continued recovery fueled by low interest rates and a new stimulus bill, though the pace of growth is uncertain.

In Newsweek, ECRI's Lakshman Achuthan tells Daniel Gross that market jitters about a double-dip recession are overblown, since "you always have a spurt in growth out of recession and then you throttle back. But we'd need to see a pronounced, pervasive, and persistent decline in the level of the leading indicators to start talking about recession risk."


Read David Cameron's June 1 speech on transforming the British economy.

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