Recessions, Budget Deficits and Austerity: A Comment on the USA and European Economies

In the last few years the U.S. economy and a number of Eurozone countries have experienced a recession. One of the results of the recessions has been an increase in their budget deficits and national debts. Both in the U.S. and in Europe policies of austerity have gained momentum. It is questionable however, that in periods of recession austerity leading to reductions of aggregate spending is the answer. It can be argued that emphasis on growth may be a preferable alternative. A look at the U.S. economy in 1998, 1999, 2000, and 2001 we find that because of strong growth unemployment was about 4 percent and budget surpluses characterized all four years. In the case of Europe the countries with most difficulties are peripheral countries of the European Union, e.g., Italy, Spain, Portugal, Greece. This raises the question, on whether the integration of small and large countries and of different standards of living was a wise move. Concerns about this issue led the Single European Act of 1986 to emphasize the need for social and economic cohesion. An outcome of this was the use of structural funds primarily to the peripheral countries. Yet, we know that social value changes and economic development take time. Germany, the largest and richest country of the Union seems to be playing a dominant role currently in urging austerity for the peripheral countries which have large deficits and debts. Suggestions that the European Central Bank act as a bank of last resort by lending directly to the various governments in need and/or the creation of Eurobonds have been rejected by the Eurozone leadership. Leaders in Brussels have also voted recently for strict budget criteria for the Eurozone members. Among the peripheral countries in difficulty Greece is the worst case scenario. The Greek economy has shrunk by 7.5 per cent in the fourth quarter of 2011 and young people in Greece experience unemployment of 51 per cent. On February 9, 2012 the Greek government was able to convince private bondholders to accept a 75 per cent loss in the face value of bond holdings. The result of this was a reduction in Greece’s debt by 100 billion Euros. At the same time the Eurozone and IMF are expected to provide Greece with a stopgap package of 130 billion Euros. These developments do not mean that Greece is out of the woods. Its indebtedness is now with Europe and the IMF. It’s debt to GDP ratio would still be 151 per cent in 2012, the highest in Europe. The challenges facing the new government resulting from the elections of June 17, 2012 are staggering. Other countries, e.g., Italy and Spain are also facing economic declines and are potentially candidates for bailouts. It is because of this possibility that the Managing Director of the IMF has been urging Europe to raise at least $1 trillion in emergency funds. At this point, it is not clear how the European crisis will be resolved. Perhaps two basic questions may be raised: 1) would the strongest economies be willing to help more effectively the peripheral countries in trouble? 2) Would the “failed†policy of austerity in depressed economies be changed by more emphasis on growth? At present, it appears that a balanced policy including more emphasis on demand side economics makes sense in both the USA and Europe.