Austerity Measures? An Erudite's Opinion

Being one who keeps up with the news, I’ve been paying some attention to reactions to the austerity measures throughout Europe over the past year or so.   I actually have been quite surprised that Europe had been accepting austerity measures as much of they have in Europe after initial public discontent.  Technocratic prime ministers in Italy and Greece have strong public support and voters have elected reforming governments in Spain, Portugal and Ireland.  However, with the recent economic slowdowns in Britain, Spain, Germany, Italy and the Netherlands as well as political discontent in France and the Netherlands regarding austerity measures, many are casting doubts on the effectiveness of austerity measures.  Generally, they use the Keynesian argument that restricting government investment reduces demand at a macroeconomic level, which in turn reduces economic activity and growth.  They captiously state the events cited above as proof that austerity doesn’t work and government needs to “prime the pump.”

As you may suspect, I was skeptical of such a point of view.  But I decided during my visit to Carleton last week that I would ask for the normative opinion of a much smarter man than I, a Carleton economics professor.  So I asked him bluntly about whether he agrees with the critics of austerity measures in Europe.  The professor gave an insightful answer.

·      After the disclaimer that he was skeptical of macroeconomics in general, he said that the critics of austerity measures in Europe should look at them in context.  These countries imposed austerity measures because the interest of their debts was crowding out all other public investments.  Therefore, these countries forced to enact austerity measures or lose the confidence of the entire international finance community as well as probably their voters.

·      Thus, if the cost of paying interest in the debt crowding out public investment opportunities is the case, the answer is simply not to take measures to increase the debt’s principal, thus increasing the cost of debt servicing.  The answer is to attempt to lower fiscal obligations and decrease the debt principal not only to increase fiscal capacity, but also to create confidence for outside investment.  Thus, the economic effect of initial spending cuts will be negative, but once confidence is gained by domestic and foreign investors in a particular country due to structural stability, the country’s economic will be stronger over the longer term.

·      What would that mean for the United States if it imposed austerity measures? The professor conjectured that perhaps in the short term there could be a slowdown.  However, it would create much more certainty of a more stable fiscal condition over time as well as opportunities to encourage stronger long-term economic growth as well as an improved debt rating.

So that was the professor’s tidbit.   If the professor wants to correct my lack of interpretive insight, please let me know and I’ll make the corrections as needed.