Austere Growth?

WASHINGTON, DC – The German government’s reaction to newly elected French President François Hollande’s call for more growth-oriented policies was to say that there should be no change in the eurozone’s austerity programs. Rather, growth-supporting measures, such as more lending by the European Investment Bank or issuance of jointly guaranteed project bonds to finance specific investments, could be “added” to these programs.

Many inside and outside of Germany declare that both austerity and more growth are needed, and that more emphasis on growth does not mean any decrease in austerity. The drama of the ongoing eurozone crisis has focused attention on Europe, but how the austerity-growth debate plays out there is more broadly relevant, including for the United States.

Three essential points need to be established. First, in a situation of widespread unemployment and excess capacity, short-run output is determined primarily by demand, not supply. In the eurozone’s member countries, only fiscal policy is possible at the national level, because the European Central Bank controls monetary policy. So, yes, more immediate growth does require slower reduction in fiscal deficits.

The only counterargument is that slower fiscal adjustment would further reduce confidence and thereby defeat the purpose by resulting in lower private spending. This might be true if a country were to declare that it was basically giving up on fiscal consolidation plans and the international support associated with it, but it is highly unlikely if a country decides to lengthen the period of fiscal adjustment in consultation with supporting institutions such as the International Monetary Fund. Indeed, the IMF explicitly recommended slower fiscal consolidation for Spain in its 2012 World Economic Outlook.