The West’s horrible fiscal choice
The US, Britain, and Europe are together embarking on a sudden and severe tightening of fiscal policy, in unison, before economic recovery has reached safe take-off speed. The experiment was last tried in the 1930s.
By Ambrose Evans-Pritchard
The theoretical model behind the austerity push – known as an “expansionary fiscal contraction” – is based on the work of German theorists, and more recently on studies by Harvard professor Alberto Alesina and a group of brave scholars willing to defy the canonical doctrine of post-war Keynesian economics.
The Alesina view has been embraced by the European Central Bank and the budget cutters of the Eurogroup, but has enraged America’s professoriat and set off a heated argument across the world.
Former US Treasury Secretary Larry Summers said there is now a one-third chance of a full-blown recession next year in the US. Nobel leaureate Paul Krugman said obscurantists had run amok. “What we’re witnessing here is a catastrophe on multiple levels. We are doing a terrible thing. We are repeating all the mistakes of the 1930s, doing our best shot at recreating the Great Depression,” he said.
Fear that a synchronized squeeze in half the global economy may go horribly wrong has seeped into market psychology, explaining why the $2.4 trillion (£1.5 trillion) debt deal agreed in Washington has failed to spark a relief rally. Wall Street is a step ahead, bracing for cuts in an economy that has already slipped to stall speed.
Angst over faltering recovery explains why Italian and Spanish bonds have suddenly buckled. The European Commission said the spike in Latin spreads is “clearly unwarranted” given that Rome and Madrid are sticking to their austerity plans, but this misses the point.