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Simon Wren-Lewis: The ‘Official’ Cost of Austerity: Noted

Mainly macro The official cost of austerity

Simon Wren-Lewis: The ‘official’ cost of austerity:

Jan in‘t Veld uses the European Commission’s QUEST model to estimate the impact of fiscal consolidation in the Eurozone (EZ) from 2011 to 2013... includ[ing] spillover effects from other EZ country fiscal consolidations, so they are best interpreted as the impact of overall EZ fiscal consolidation over this period.... Of course many would argue that had countries like Spain or Greece not undertaken this degree of austerity, long term interest rates might have been even higher than they actually were.... However a significant amount of fiscal consolidation took place in Germany, and this had significant spillover effects on other EZ countries. It is difficult to see why that consolidation was required to ease funding pressures....

Of course QUEST is just one DSGE model, which just happens to be maintained by the Commission. An earlier study (pdf) by Holland and Portes at NIESR had important differences in detail, but the bottom line was similar: EZ GDP was 4% lower in 2013, and the cumulated GDP loss was 8.6%. These numbers are of course large, and so it is quite reasonable to say that the proximate cause of the second EZ recession is simply austerity.

Now many would argue that much of this was forced by the 2010 crisis. There seems to be a mood of fatalism among many in Europe that this was all largely unavoidable. I think that is quite wrong. Some fiscal tightening in Greece was inevitable, but if EZ policy makers had taken a much more realistic view about how much debt had to be written off, we could have avoided the current disaster. What ended the EZ crisis was not austerity but OMT: if that had been rolled out in 2010 rather than 2012, other periphery countries could also have adjusted more gradually. And of course fiscal consolidation in Germany and some other core countries was not required at all...

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