The Corner

More Spending Won’t Save Europe

In the face of the problems in Europe, many have suggested that the solution is for Germany to provide the necessary stimulus (through, among other things, a boost of German domestic demand and/or an erosion of its current-account surplus) to help other countries fix their fiscal troubles. But that’s unlikely to work, says Amit Kara:

Even if Germany manages to increase domestic demand, there is no guarantee that the additional spending will find its way into the peripheral euro-zone economies. A simple macroeconomic simulation suggests that a permanent increase in German government consumption equivalent to one percentage point of GDP would raise output in Ireland and Greece by 0.1% at most, and in larger countries, such as Spain and Italy, by much less than that.

That should come as no surprise. After all, exports to Germany account for just 2.5% of the combined GDP of Italy, Ireland, Portugal, Spain and Greece. In order to make a difference, Germany would therefore have to embark on a fiscal expansion that is too big even for the largest economy in Europe.

What about households and companies? German household saving is relatively high at 11%, in theory providing some scope for additional private spending. Here, too, however, there are difficulties. Designing a fiscally neutral set of measures that encouraged spending would be challenging because German households have, on average, less net wealth than their counterparts in France or Italy.

There is also the possibility of faster wage growth in Germany, which would undoubtedly help stimulate consumption. But only a small portion of that additional spending would be directed toward the troubled countries. And Finance Minister Wolfgang Schäuble, while acknowledging the likelihood of more rapid German wage growth, also warned that the economy should not lose its focus on competitiveness, implying that there is a limit to how much wage growth German authorities will tolerate.

What if German corporations spent more? That would help, but it is not clear how the German government can help channel that spending to the peripheral economies.

Then what? In this piece in the LA Times on Friday, I argued that European countries should stay away from the “balanced approach” to austerity, that is, some spending cuts coupled with counter-productive tax increases. Tax increases (private-sector austerity), especially in times of economic contractions, are never a good idea or a good way to promote growth. That’s true even in a Keynesian model. Yet, we aren’t hearing anti-austerity advocates complain loudly that Europeans are raising taxes. Where are the headlines saying, “Europe needs to stop raising taxes”? Instead, we read that spending, and the lack of it, is to blame for austerity. Maybe that’s because acknowledging that austerity through spending cuts and tax increases has produced terrible results in Europe makes it hard to continue calling for tax increases–even if only on the rich–in the the US’s weak economy.

Obviously, I disagree that stimulus through spending should be pursued in Europe. Instead, along with cutting taxes, failing European governments should cut government spending. This form of austerity accompanied by the “right policies” (according to Harvard’s Alesina that’s easy monetary policy, liberalization of goods and labor markets, and other structural reforms) is more likely associated with economic expansions rather than with recessions. As I explained before, this makes intuitive sense: Austerity based on spending cuts (austerity in government) signals that a country is serious about getting its fiscal house in order in a way that taxing and more spending does not.

That leads us to the role of monetary policy. For over three years, economist Scott Sumner has argued that monetary stimulus is the best way to go. He explains how to get austerity and growth:

So let’s see, how do we get austerity and stimulus at the same time?  How about easy money and deficit spending?  No, that won’t work.  Tight money and budget surpluses?  No.  Tight money and big deficits?  Hell no, that’s what we’ve been doing.  That’s how we got into this mess.  How about easy money and budget surpluses?  Bingo.  That’s a growing NGDP and budget surpluses—the Swedish way.

Read also his post about the successful austerity measures implemented in Sweden and the lesson for England: no Keynesian stimulus, what may look like social-transfer spending cuts, and a 2009 monetary stimulus. Sumner writes:

Readers of TheMoneyIllusion were the first to find out about the Swedish monetary stimulus back in 2009.  But that begs raises another question.  Isn’t Britain also outside the euro?  If monetary stimulus makes fiscal stimulus unnecessary (and it does), then why would Britain want to do fiscal stimulus?  Why not just do monetary stimulus, and avoid the big deficits?  After all, just the other day didn’t Krugman say that there’s no argument at all for fiscal stimulus when monetary stimulus is available?  Yes he did.  And now he’s (correctly) attributing Sweden’s relative success to monetary stimulus (it sure wasn’t deficit spending!)

The whole thing is here. In my view, monetary policy in Europe, or in the U.S. for that matter, would increase the effectiveness of spending cuts and structural reforms (kind of like the water you drink to help the medicine go down). There may even be a good case that it would be useful independently of other reforms. But it is mistake to oversell it and it certainly won’t achieve our long term goals without serious reductions is government spending.

For more nonsense from Europe, read this. It explains a lot of this.

(Thanks to Tyler Cowen for sending me the WSJ piece about Germany.)


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