Austerity plus uncertainty equals more contraction

Slí Eile18/08/2011

Slí Eile: Voxeu had an interesting contribution by Miguel Kiguel [Argentina and Greece: More similarities than differences in the initial conditions] here.

Kiguel recounting the experience of Argentina over a decade ago writes:

"The fiscal contraction failed to restore confidence. It made the recession worse, thereby reducing tax revenues. The reaction was to embrace more draconian austerity which deepened the recession and further cut tax receipts. This was a vicious circle with no way out.The fundamental problem was that the fiscal adjustments did not—as had been expected restore solvency and investor confidence, just the opposite. Something similar is happening today in Greece, where fiscal austerity is failing to restore confidence and is making the recession worse. In the end, investors know that growth is the only way to get out of the debt trap and it does not seem that it will happen through reductions in government expenditures or increases in taxes. Deflation is not happening either, and therefore the big question is how and when Greece can grow. ......

A first lesson is that reductions in the fiscal deficit through decreases in nominal expenditures or increases in taxes in the midst of a recession do not work austerity just makes the recession worse.

The second lesson is that when the public sector is large and there are powerful unions, it is extremely difficult to correct an overvalued currency through deflation.

A third lesson is that a devaluation in a dollarised economy (euro-ised in the case of Greece) can be problematic as it can lead to significant balance-sheet problems that need some form of government intervention.

A fourth lesson is that non-convertible quasi-currencies (QCs) can be a roundabout away to restore a limited degree of monetary and exchange rate policies."

Anybody doubting that the Greek Government is not doing enough to deflate the real economy should check the summary of actions on the Greek Ministry of Finance website here. Cuts of over 15% in nominal wages in the public sector, closure of 2,000 schools, across the board cuts in health, social security, privitisation. It is a thorough package to embed debt in a contracting economy and ensure continuing insolvency along with a very limited private sector participation in debt write-downs via a bail-in.

Posted in: EconomicsEconomicsEurope

Tagged with: ArgentinaDeflationGreece


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