Europe and Keynesian Economics

Recently, I was researching a post on US v EU unemployment. No.1 on Google (a news result) was a post with some observations on EU vs US economic policy. This paragraph caught my attention

…But many European countries have completely mismanaged their budgets for continued government stimulus, which lends to the argument of free market supports that Keynesian economics is unsustainable. Greece is relying on the most recent bailout to pay its bills and creditors want to see further cuts. Spain is also cutting spending, while dealing with a revived separatist movement of the Catalan province that does not want to pay the country’s bills. Both of these countries have the eurozone’s highest unemployment rates of 25 percent apiece. (AIM.org)

A few observations sprang to mind:

  1. Europe is not pursuing Keynesian economics! To slash spending in a recession is the opposite of what Keynesian economics proposes. You could argue Keynesian economics (stimulus spending in a recession) is not going to be helpful, you could argue fiscal stimulus is undesirable when bond rates are rising; but, I don’t even think the most ardent critic of Keynesian economics would try to argue countries in the Eurozone are actually pursuing Keynesian economics.
  2. ‘continued government stimulus’ There is a tendency to assume that countries with high levels of government spending as a % of GDP are ‘Keynesian’. Keynesian fiscal policy aims to be counter-cyclical. In a boom, that means reducing the deficit to dampen consumer spending. For example, in a boom a very large tax cut (e.g. Bush tax cut in US) is not desirable. A boom is a time to reduce the deficit not widen it. Keynesian fiscal policy essential suggests government should spend when there is a very large rise in private sector saving to prevent unemployed resources.
  3. Excessive Government debt wasn’t the main cause of the EU crisis. Many in US, (and to be fair most of the EU elite) have portrayed this crisis as a mismanagement of debt. But, with the exception of Greece, debt levels in Eurozone economies were relatively low before the start of the crisis. Spanish (37% of GDP) and Irish debt (25% of GDP) were much lower than Germany’s. Given the nature of the boom, appropriate Keynesian counter cyclical policies would have involved having higher taxes / lower spending ) and a even lower debt before the crisis.  But, the Euro crisis is based in the failings of a single currency and fixed exchange rate of the Euro. (Euro crisis Explained)
  4. In the long term, Europe and US may need careful examination of long-term spending commitments. With an ageing population there may need to be reforms to welfare entitlements. But, this need to deal with long-term deficit is a different issue to the short term issue of insufficient demand. The evidence from Europe is that austerity policies are close to being self-defeating.
  5. One reason the US recovery has been stronger than Europe is that the relatively small US fiscal stimulus (it was small when you combine federal and state spending) in US helped maintain demand – compared to Europe where cutting government spending has added to the fall in private sector spending.

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  1. Pingback: 5 vor 10: Interviews, Griechenland, Konjunkturentwicklung, Bezahlsysteme, Ökonomie | INSM Blog

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