May 2012, Week 1


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Mon, 7 May 2012 22:10:38 -0400
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After Austerity

By Joseph E. Stiglitz

Monday, May 7th 

Nation of Change


This year's annual meeting of the International
Monetary Fund made clear that Europe and the
international community remain rudderless when it comes
to economic policy. Financial leaders, from finance
ministers to leaders of private financial institutions,
reiterated the current mantra: the crisis countries
have to get their houses in order, reduce their
deficits, bring down their national debts, undertake
structural reforms, and promote growth. Confidence, it
was repeatedly said, needs to be restored.

It is a little precious to hear such pontifications
from those who, at the helm of central banks, finance
ministries, and private banks, steered the global
financial system to the brink of ruin - and created the
ongoing mess. Worse, seldom is it explained how to
square the circle. How can confidence be restored as
the crisis economies plunge into recession? How can
growth be revived when austerity will almost surely
mean a further decrease in aggregate demand, sending
output and employment even lower? 

This we should know by now: markets on their own are
not stable. Not only do they repeatedly generate
destabilizing asset bubbles, but, when demand weakens,
forces that exacerbate the downturn come into play.
Unemployment, and fear that it will spread, drives down
wages, incomes, and consumption - and thus total
demand. Decreased rates of household formation - young
Americans, for example, are increasingly moving back in
with their parents - depress housing prices, leading to
still more foreclosures. States with balanced-budget
frameworks are forced to cut spending as tax revenues
fall - an automatic destabilizer that Europe seems
mindlessly bent on adopting.

There are alternative strategies. Some countries, like
Germany, have room for fiscal maneuver. Using it for
investment would enhance long-term growth, with
positive spillovers to the rest of Europe. A
long-recognized principle is that balanced expansion of
taxes and spending stimulates the economy; if the
program is well designed (taxes at the top, combined
with spending on education), the increase in GDP and
employment can be significant.

Europe as a whole is not in bad fiscal shape; its
debt-to-GDP ratio compares favorably with that of the
United States. If each US state were totally
responsible for its own budget, including paying all
unemployment benefits, America, too, would be in fiscal
crisis. The lesson is obvious:  the whole is more than
the sum of its parts. If Europe - particularly the
European Central Bank - were to borrow, and re-lend the
proceeds, the costs of servicing Europe's debt would
fall, creating room for the kinds of expenditure that
would promote growth and employment.

There are already institutions within Europe, such as
the European Investment Bank, that could help finance
needed investments in the cash-starved economies. The
EIB should expand its lending. There need to be
increased funds available to support small and
medium-size enterprises - the main source of job
creation in all economies - which is especially
important, given that credit contraction by banks hits
these enterprises especially hard.

Europe's single-minded focus on austerity is a result
of a misdiagnosis of its problems. Greece overspent,
but Spain and Ireland had fiscal surpluses and low
debt-to-GDP ratios before the crisis. Giving lectures
about fiscal prudence is beside the point. Taking the
lectures seriously -  even adopting tight budget
frameworks - can be counterproductive. Regardless of
whether Europe's problems are temporary or fundamental
- the Eurozone, for example, is far from an "optimal"
currency area, and tax competition in a free-trade and
free-migration area can erode a viable state -
austerity will make matters worse.

The consequences of Europe's rush to austerity will be
long-lasting and possibly severe. If the euro survives,
it will come at the price of high unemployment and
enormous suffering, especially in the crisis countries.
And the crisis itself almost surely will spread.
Firewalls won't work, if kerosene is simultaneously
thrown on the fire, as Europe seems committed to doing:
there is no example of a large economy - and Europe is
the world's largest - recovering as a result of

As a result, society's most valuable asset, its human
capital, is being wasted and even destroyed. Young
people who are long deprived of a decent job - and
youth unemployment in some countries is approaching or
exceeding 50%, and has been unacceptably high since
2008 - become alienated. When they eventually find
work, it will be at a much lower wage. Normally, youth
is a time when skills get built up; now, it is a time
when they atrophy.

So many economies are vulnerable to natural disasters -
earthquakes, floods, typhoons, hurricanes, tsunamis -
that adding a man-made disaster is all the more tragic.
But that is what Europe is doing. Indeed, its leaders'
willful ignorance of the lessons of the past is

The pain that Europe, especially its poor and young, is
suffering is unnecessary. Fortunately, there is an
alternative. But delay in grasping it will be very
costly, and Europe is running out of time.

This article was published at NationofChange at:
1336401779. All rights are reserved.


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