Yes, Public-sector Austerity Can Work

by Veronique de Rugy

Today is a good day. Two separate media stories have acknowledged that public sector austerity — meaning spending cuts rather than tax increases — can actually bring debt-to-GDP levels down, and it may even produce economic growth.

First, this story reports that French IMF director Christine Lagarde hailed Latvia as a country where public-sector austerity worked:

RIGA: IMF chief Christine Lagarde pointed yesterday to Latvia as model for states like Greece balking at belt-tightening as the euro-zone debates whether the focus should shift from austerity to growth.”Latvia decided to bite the bullet and instead of spreading the pain over a number of years-doing it gently … you decided to go hard and to go quickly,” Lagarde told delegates to an International Monetary Fund conference in the Latvian capital Riga on lessons from its spectacular recovery.  Latvia and its Baltic neighbours Estonia and Lithuania in the EU’s northeastern corner consider austerity as the cure to their deep recessions sparked by the 2008 global financial crisis.

Lagarde called Latvia’s performance under a 2008-2009 7.5-billion-euro ($9.4 billion) IMF-EU bailout “incredibly impressive,” with sharp spending cutbacks helping it reduce its public deficit by 8.0 percentage points of gross domestic product in one year. Latvia’s economy contracted by a cumulative 25 percent during the crisis, the deepest plunge recorded worldwide, but the ex-Soviet Baltic state of two million began to recover last year when it clocked 5.5 percent growth.  The ‘bite-the-bullet’ approach stands in stark contrast to that of Greece, which has been slow to implement structural reforms and has repeatedly missed targets on reducing its public deficit.

Earlier, Lagarde told the Swedish daily Svenska Dagbladet that one lesson from Latvia’s experience is that cutbacks need to be made early on,” noting the risk of reform fatigue if austerity measures are not introduced at once.

I wonder what her conversation with Hollande will be next time she sees him. (Thanks to Don Boudreaux for the pointer).

Second, this morning NPR also had a story about the recent successful fiscal adjustments in the Baltic nations through spending cuts, and their policy of allowing prices to fall. I, for one, wished we engaged in more of this behavior in the U.S., especially in the housing market.

I wrote about the Baltic nations’ fiscal adjustments in the Washington Examiner a few weeks ago.

The success in the Baltic nations, by the way, is also explained by their ability to use monetary policy to accommodate their fiscal restraints.

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