Tuesday, November 29, 2011

The Simple Logic of Fiscal Discipline

One of the main arguments used against fiscal discipline during a crisis is that it would make the fiscal situation worse. You don't need to think too hard to know that this is the leftist equivalent of the rightist Laffer curve argument for growth. Daniel Gros kills cartoonish-Keynesian dreams with a shot of cold logic:

So what should governments do? Abandon austerity because financial markets might be shortsighted? This would only delay the day of reckoning as debt ratios would increase in the long run.

  • A country which enters a period of heightened risk aversion with a large debt overhang faces only bad choices.
  • Implementing credible austerity plans constitutes the lesser evil, even if this aggravates the cyclical downturn in the short.

All in all, the conclusion is that it difficult to argue that the peripheral countries in the Eurozone should abandon attempts to reduce their deficits because the results will arrive only in the long run.

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