Europe's Suicide Pact

Coordinated fiscal contraction in Europe is not only suppressing growth, it's increasing the very debt-to-GDP ratios it's meant to reduce, says Jonathan Portes of Britain's National Institute of Economic and Social Research. In a piece for the Guardian--This is a European suicide pact--he draws attention to a new NIESR study which looks at this issue carefully. He thinks it's the first such effort (a remarkable claim in itself).

Fiscal policy started to achieve the opposite of what was intended in 2011, when deep consolidation measures were introduced in Portugal, Ireland and Greece - the three countries on bail-out programmes. Cumulative measures over the three-year period amount to close to 10% of GDP in Greece and Portugal and 8% in Ireland. Consolidation measures amounting to between 5% and 6% of GDP are planned in France, Italy, Spain and the UK, while only a modest adjustment is likely in Germany and Austria.

Our estimates are that in those normal times, fiscal consolidation would have reduced growth, but not by very much except in the bailout countries: the cumulative impact ranging from almost nothing in Germany to 8% in Greece and Portugal. The desired objective of reducing deficits and debt would have been achieved. But taking account of the current environment changes the picture dramatically: the hit to output in Germany is now 2%. In the UK it is 5%; and in Greece 13%. Still more shocking is the impact on debt-to-GDP ratios - the fiscal consolidation was supposed to improve fiscal sustainability; instead, it makes matters worse. And this isn't true just in extreme cases like Greece - fiscal consolidation across the EU has raised debt-to-GDP ratios in Germany and the UK as well. In both the UK and the euro area as a whole, the result of coordinated fiscal consolidation is a rise in the debt-GDP ratio of approximately five percentage points. For the UK, that means a debt-GDP ratio of close to 75% in 2013 instead of about 70%. We are not running to stand still; we are determinedly heading in the wrong direction.

Here's the full study: Less Austerity, More Growth? by Dawn Holland.