The last month has seen a virtual earthquake in the framework for economic policy following the 2008 collapse. The conclusions of Reinhart-Rogoff paper, which has been widely cited as the basis for austerity, were shown to be driven by spreadsheet errors. The corrected calculations provide no evidence for the dreaded debt cliff. Furthermore, subsequent analysis has shown that whatever link exists between debt and slow growth is almost exclusively the result of causation running from slow growth to high debt.
This new evidence should be sufficient to prompt a serious rethinking of the austerity agenda, especially in the euro zone countries where it has caused the most damage. Unfortunately, no change of course seems likely with top officials in the European Central Bank and the European Union remaining determined to pursue their austerity agenda regardless of what the evidence shows.
This agenda implies enormous pain for the crisis countries. The most hard hit countries, like Greece, Spain, and Portugal, would almost certainly be better off leaving the euro at this point. However, their leaders lack the political will to take this step, which means that they can look forward to a prolonged period of recession or stagnation and double digit unemployment.
The goal of this policy is to force down wages to the point where the crisis countries are again competitive with Germany and northern Europe. This may be doable, but the process could well require a decade or more. It should be clear to everyone by now that wages do not fall easily. If Germany refuses to allow more rapid inflation in the northern countries then the process of falling wages and prices in southern Europe will be a long slow grind.