The title is not my creation, but just a continuation of the VoxEU article by the ECB’s Lorenzo Bini Smaghi. Here is the abstract:
Today’s austerity, many argue, is stupid. This column argues that today’s EZ austerity may arise from stupidity before the crisis – specifically lacklustre structural reform. Excess debt arose in nations maintaining unsustainable living standards and welfare systems in the face of poor growth. The Crisis forced radical adjustments such as austerity in a recession. It’s not austerity which caused low growth, but low pre-Crisis growth which ultimately caused austerity. The way out of austerity is fundamental pro-growth reforms that create room for more gradual fiscal adjustment.
I put this article aside to think about it because my first impression was that this piece is rather strange and deserves a strong reply. Maybe over time I would think differently? No, I don’t. Let me just very quickly go through the abstract.
Today’s austerity, many argue, is stupid.
Well, I haven’t heard a respectable economist saying that. Today’s austerity is many things, perhaps unwise, unfairly putting costs on the relatively poor, not the pareto-optimal mechanism of adjustment, something like this. Austerity is stupid? I don’t know any economist who is on the record for saying this. A quick Google search does not lead to success either. Some journalists have apparently said it, but there’s no quote from any economist. My conclusion: Bini Smaghi creates a straw man. He says: “some say”, doesn’t say who he means, and then attacks this “some say” and is not counter-attacked because nobody identifies with his straw man. This is probably normal in political propaganda, but not a way a central banker should communicate with the public, or in this case, academia.
This column argues that today’s EZ austerity may arise from stupidity before the crisis – specifically lacklustre structural reform.
Well, you can argue that, but let’s face it. In the European treaties there was no provision saying that “nations in economic troubles approaching depression levels of unemployment will be treated harshly”. So, austerity policy was a discrete policy choice, nothing automatic that was clear when the euro was designed. Remember all the talk about asymmetric shocks and how market adjustment would take care of any problems? Let’s go back in time and look at a publication from the European parliament:
All these fears and arguments may perhaps be summed up in a single proposition: that the European Union does not constitute an “optimum currency area”. In such circumstances, it is maintained, the gains from EMU in terms of reduced transaction charges, increased price transparency, etc. will be more than offset by losses in production and employment. […]
But EMU is going ahead. Contrary to many predictions, the 1999 start-date is being met, and with the participation of all but four EU Member States. Whether this will prove evidence of courage and clear-sighted vision, or of “cock-eyed optimism” (2), time will tell.
2. Editorial in The Times of Tuesday June 2, 1998
No further comment necessary, I’d say.
Excess debt arose in nations maintaining unsustainable living standards and welfare systems in the face of poor growth.
Perhaps we should have agreed on the same planet before talking about the EMU, because there seem to be two. Irish and Spanish sovereign debt was below 40% of GDP before the crisis. You must be talking about private sector debt then? So ok, banks allowed consumers to borrow in order to build and buy houses. That turned out to be unsustainable. But the welfare system? Well, if you knew before that banks were bailed out, then of course with hindsight the public spending would seem to have been to high. Only that back then nobody saw this coming, and the idea that Europe bails out banks and not sovereign states was not discarded yet. “In the face of poor growth”? Really? Have you actually looked at GDP growth in Spain and Ireland vis-a-vis Germany? Poor growth could only mean Germany before the crisis.
The Crisis forced radical adjustments such as austerity in a recession.
No, it didn’t. That was a discrete policy choice, and it did not have to happen. Show me the European legal texts that say that countries with economic problems – like after an asymmetric shock – are to be punished by cutting their government spending. The whole troika think and “saving the euro” by prolonging the situation was discretionary. of course, it was not an easy decision, but it was one nevertheless.
It’s not austerity which caused low growth, but low pre-Crisis growth which ultimately caused austerity.
That has been discarded above – there wa no low pre-Crisis growth in Spain and Ireland.
The way out of austerity is fundamental pro-growth reforms that create room for more gradual fiscal adjustment.
That is a very late insight on Bini Smaghis part which certain academic economists have voiced from the beginning. Is it really so hard to admit that austerity was not a good idea from the very start, that economic textbooks that introduce the IS/LM model to bachelor students say that cutting government spending in times of weak demand would be harmful for the economy, and that the reason why we teach this model is that it gets the main issue right?
If part of the answer is that the DSGE models used at the ECB have not predicted this outcome, then you should upgrade your intellectual capacity. And the sooner the better: the people of Europe are still suffering from record high levels of unemployment.