The Death of Austerity

Category: Economy | Sprott Group
April 23, 2013 | Comments Off |
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The Death of Austerity

The Death of Austerity

Last week the International Monetary Fund (“IMF”) reduced its global growth forecast and reiterated its call for some European countries to reduce their Austerity drives.

The harsh conditions imposed on bailout countries, most recently in Cyprus for example, have been vividly evident in affected countries. What has caused the IMF to change its view?

Late last year the IMF made a striking admission in its new World Economic Outlook. The IMF’s chief economist, Olivier Blanchard, explained that recent efforts by countries to shrink their deficits through tax hikes and spending cuts have been causing far more economic damage than the experts had previously assumed. IMF forecasts for countries that pursued large austerity programs had consistently been too optimistic. Conversely, countries that engaged in stimulus effort, such as Germany and Austria, did better than expected. As it turns out, a $1 cut in a budget will result in between a $0.90 to $1.70 dollar cut in GDP, rather than the $0.50 the IMF had previously assumed.1 If true, governments globally should be focused on pursuing stimulus measures to boost growth, rather than insisting on major budget cuts.

In economic parlance, the new findings suggest that the fiscal multipliers are higher than anyone had previously estimated. Whoops… sorry Greece, Portugal and Ireland. Perhaps those budget cuts that were imposed as conditions of your bailouts were misplaced. This is a major finding from the body that structures bailouts for countries, but the evidence doesn’t stop there.

Another ugly fact was revealed this past week that called into question the beautiful ‘austerity theory’. Harvard economists Ken Rogoff and Carmen Reinhart, affectionately known as the “godfathers of austerity”, had their research challenged on the basis of a spreadsheet error. The authors, famous for their research on debt, presented the idea that a country’s ratio of debt to gross domestic product of 90% or higher results in lower economic growth. Last week, a paper by Thomas Herndon, Michael Ash and Robert Pollin (HAP) argued that the 90% principle was based on simple statistical errors, including a spreadsheet error which the Harvard economists have since acknowledged. Their critique promises to establish an alternative view on governments and debt, which is that high public debt ratios are not damaging for GDP growth. Thomas Herndon in an interview this week with Business Insider suggested that, “The implication for policy is that, under particular circumstances, public debt can play a key role in overcoming a recession.” This suggests that all fiscal policy responses by governments since the crisis have been misguided. Herndon continues, “The current historical moment, with historically high rates of mass unemployment in both the U.S. and Europe and with interest rates on U.S. Treasury bonds at historic lows, is precisely the set of circumstances under which we would expect public borrowing to have large positive effects, with comparably fewer costs… Moreover, it is precisely the set of circumstances under which we expect austerity to have substantial negative effects.”2  This is a major blow to the austerity agenda being pursued by most countries in the world, and confirms the IMF’s own findings.

So ‘austerity’ may be on its deathbed, but killing something that wasn’t working is not the same as solving the problem of economic growth. A pair of unexpectedly soft regional Federal Reserve surveys last week reinforced the view that yet another spring slowdown – the fourth in as many years – is unfolding in the United States. So how can we stimulate economic growth in this environment? These new findings seem to be telling us that there is only one policy response remaining:  more monetary easing.

2 http://www.businessinsider.com/herndon-responds-to-reinhart-rogoff-2013-4

Courtesy: David Franklin – Sprott Group

Disclaimer

The views and opinions expressed herein are the author’s own, and do not necessarily reflect those of Commoditytrademantra.com or Moneyline.co.in.


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