Austerity as a substitute for trust

Here is a common view, not incorrect as far as it goes:

Struggling euro-zone economies like Greece, Portugal, Spain and Italy cannot cut their way back to growth. Demanding rigid austerity from them as the price of European support has lengthened and deepened their recessions. It has made their debts harder, not easier, to pay off.

And here is a useful Paul Krugman post on austerity, perhaps the best single (brief) statement of his views on European austerity.  Three observations:

1. I have yet to see a numerical analysis of European fiscal austerity which adjusts for a) falling ngdp, b) the collapse of their banking systems, c) and the collapse of M3 and money markets in some of these regions, noting that in Italy there are partial (very recent) signs of a money market turnaround.  The blame gets pinned on the fiscal austerity.

2. I have yet to see a numerical analysis of European fiscal austerity which considers the prospect of later catch-up growth.  This can make the costs of austerity much smaller, though of course from discount rates and habit formation there is still a cost.

3. Ideally it really would be better to say “Italy, I trust you to cut spending later, after your economy has recovered.”  This cross-national trust is not present, least of all with Greece but also elsewhere.  What is the best available policy in the absence of this trust, knowing that the periphery nations have to send some kind of credible signal to the wealthier nations of the North, in return for ongoing aid?

You can think of those three points as the “frontier reasons” why not all economists agree on European austerity.  There are indeed some “dY/dG denialists,” but there are too many attacks on them and not enough explorations of the real issues.

Ironically, postponing austerity is most likely to succeed when there is lots of trust in a country (and in fact whether or not that trust is deserved).   You can imagine the Swedes agreeing to themselves “we’ll cut spending three years from now” but the Greeks not, not without external constraint.  Thus, writers who unmask the depravity of the American polity, and who polarize opinion, are oddly enough doing harm to the anti-austerity point of view.

You will find an alternative perspective on intellectual strategy here.

Here is my earlier dialogue between Fabio and Angela.


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