As the U.S. and Europe turn from stimulus to fiscal austerity, claims are heard that spending cuts actually stimulate economic growth. That is the argument heard, not just from the Republicans in the U.S. Congress, but also from the Obama Administration who have pretty much stopped listening to even mainstream macro-economists. And it is the argument of European finance ministers and the European Central Bank who think that a sharp dose of fiscal austerity across the Eurozone need not imperil economic recovery.
However, there is very rarely any such thing as expansionary austerity, according to IMF staff economists.
In a careful review of the historical evidence, they find that, typically, a 1 per cent of GDP fiscal consolidation reduces real private consumption over the next two years by 0.75 per cent, while real GDP declines by 0.62 per cent.
They do allow that the drag on GDP coming from spending cuts can sometimes be offset by positive confidence and interest rate effects if a country is facing an acute fiscal crisis, and that the effects of fiscal contraction can also be offset by a weaker exchange rate, as was the case for Canada under Chretien and Paul Martin.
But, as a rule, the Keynesian position that reduction of government spending reduces short-term effective demand and thus growth and employment is found to be supported by a less selective reading of the evidence than that of Alesina and other right-wing economists.
For Canadians this is surely sobering. We face no fiscal crisis -- our net debt is far below the OECD average. Austerity cannot produce lower interest rates -- short-term rates are near zero and the 10-year Government of Canada bond rate is at a near historic low of under 3 per cent. And, with the dollar hugely over-valued and the U.S. teetering on the edge of another downturn, there will be no offset to fiscal contraction from higher exports this time around.
As we begin the 2012 federal budget debate, Flaherty must be asked why his planned cuts do not risk derailing an already very fragile recovery.
This article was first posted on The Progressive Economics Forum.
Thank you for reading this story…
More people are reading rabble.ca than ever and unlike many news organizations, we have never put up a paywall – at rabble we’ve always believed in making our reporting and analysis free to all, while striving to make it sustainable as well. Media isn’t free to produce. rabble’s total budget is likely less than what big corporate media spend on photocopying (we kid you not!) and we do not have any major foundation, sponsor or angel investor. Our main supporters are people and organizations -- like you. This is why we need your help. You are what keep us sustainable.
rabble.ca has staked its existence on you. We live or die on community support -- your support! We get hundreds of thousands of visitors and we believe in them. We believe in you. We believe people will put in what they can for the greater good. We call that sustainable.
So what is the easy answer for us? Depend on a community of visitors who care passionately about media that amplifies the voices of people struggling for change and justice. It really is that simple. When the people who visit rabble care enough to contribute a bit then it works for everyone.
And so we’re asking you if you could make a donation, right now, to help us carry forward on our mission. Make a donation today.