Austerity Psychosis

The last Friday of 2011 saw headlines of Spain’s new center right government pledge to implement a tough austerity program in an attempt to “turn the economy around”.  It is an oxymoron in itself to have austerity and growth to turn an economy around in the same sentence.

There must not be a single unbiased observer of what has been unfolding in Europe in the last two years that does not recognise the fact that “expansionary austerity” has failed, has failed so miserably since it was first introduced in Greece in May 2010 that has turned a minor deficit issue of a country representing less than 3% of eurozone’s GDP into a full-blown crisis that threatens to bring down the entire euro structure as we currently know it.

Portugal, Ireland, Italy, Spain all going down the same destructive path dictated by Germany in exchange of ECB support and so-called ‘bail-out’ programs that only intended to keep the stability of, the heavily exposed  to the periphery, banking systems of the ‘benefactors’ Germany and France.

When exactly did we forget about fiscal policy?

In his iconic 1948 book Economics, Paul A. Samuelson, one of the most respected and influential economists of the 20th century,  wrote “…, it is absolutely certain that, just as no nation will sit idly by and let smallpox decimate the population, so too in every country fiscal policy always comes into play whenever depressions gain headway”.

At a time when austerity is the dogma of key European leaders and iron fiscal discipline perceived as the response to the escalating eurozone crisis, it is worth looking back at the basics of positive fiscal policy and how the prudent use of it can be the actual response to regaining growth, stability and confidence in the eurozone.

“Countercyclical compensatory” or “anticyclical” fiscal policy is a powerful tool in the hands of governments, used to dampen down the amplitude of the business cycle and, equally importantly, it involves a budget that is balanced over the business cycle.