The austerity debate misses half the point. It is true that governments, especially in the euro zone, shouldn’t chase an austerity spiral ever downwards. But they can’t just sit on their hands. They must drive even harder for structural reforms.
The last few weeks have witnessed a sea-change in the debate over fiscal austerity. A seminal academic paper by Carmen Reinhart and Kenneth Rogoff, which purported to show that economic growth was impaired if government debt levels exceeded 90 percent of GDP, has been discredited.
Meanwhile, the European Commission has softened its line on the merits of further deep budget cuts in peripheral economies. Spain, for example, looks like it will get until 2016 to bring its deficit down below the European Union’s magic number of 3 percent of GDP. Portugal, Greece, Italy and France are also being shown greater leniency by Brussels. One of the first things Enrico Letta, Italy’s new prime minister, said last week was that country needed to focus on growth not austerity.
The change in attitude didn’t all happen in the past few weeks. The International Monetary Fund, which in the old days used to be considered the high priest of austerity, has been advocating looser policies for a good year. And, as more countries have got sucked into the austerity spiral – slamming on the brakes, which crushes the economy, making it harder to hit budget targets – the folly of continuing with the same policies has been hard to ignore.
It is astonishing to think that it was only in December 2011 that virtually the entire EU, including most countries outside the euro zone, signed up to the German-inspired “fiscal compact” – a misguided treaty which hardwires austerity into governments’ constitutions. It will be interesting to see whether this has any residual role or, like the euro zone’s original growth and stability pact, is viewed as a piece of waste paper.