by Dirk Ehnts, Econoblog101
In a recent speech (from February 28th), European Commissioner for Economic and Monetary Affairs and the Euro and vice president of the European Commission Olli Rehn said the following things:
While I am not sure if Keynes himself would be a Keynesian today, at least an unreconstructed one, I am in fact a Keynesian myself, if that is measured by one’s belief in the dangers of a liquidity trap and the rationale of counter-cyclical economic policy.
In other words, once you have room for fiscal manoeuvre, you can pursue counter-cyclical economic policies, with targeted investment for growth-enhancing purposes like research and infrastructures, as in Sweden today. But I also live in the real world, under the shadow of a confidence crisis and of public debt at 90% on average in Europe. Even Germany’s public debt exceeds 80% of GDP. This is a world of hard choices, imperfect policy options, a still fragile financial sector, intense market pressure and political and financial constraints.
It is clear that Olli Rehn is a politicians, and hence entitled to his opinions. But note that as an economist I have to point out that government debt above 80 or 90 percent is not an automatic problem whereas unemployment rates of above 15% and rising indeed is one.
On the other side of the pond, two days earlier, Fed chairman Ben Bernanke held a speech which contains these paragraphs (my highlighting):
Significant progress has been made recently toward reducing the federal budget deficit over the next few years. The projections released earlier this month by the Congressional Budget Office (CBO) indicate that, under current law, the federal deficit will narrow from 7 percent of GDP last year to 2-1/2 percent in fiscal year 2015.8As a result, the federal debt held by the public (including that held by the Federal Reserve) is projected to remain roughly 75 percent of GDP through much of the current decade.
However, a substantial portion of the recent progress in lowering the deficit has been concentrated in near-term budget changes, which, taken together, could create a significant headwind for the economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year, relative to what it would have been otherwise. A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO’s estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant. Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.
There is no problem in being wrong about a policy. But there is a problem with being wrong about a policy and then failing to adjust. While Mr Bernanke is not an elected person, Mr Rehn is and next year we have European elections. I believe that democracy should be enough to end austerity in Europe although it is tragic that it takes so long. It was very unlucky that European elections were held in 2009 just before the outbreak of the European debt crisis, and that elections take place only every 5 years. What would have happened with social democrats in power nobody can say. However, in 2014 the dominating election issue will be austerity and it should be obvious to politicians how to win the elections.