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Wolfgang Munchau: The Return of Austerity

Wolfgang Munchau:

Austerity, like a B-movie monster, will keep coming back: Did austerity end last week? This is what the headlines suggested when the European Commission gave five eurozone countries more time to meet their fiscal targets. The message from Brussels is that policy is no longer focused on austerity but on structural reforms. I am afraid that this apparent shift in policy amounts to little more than a tactical retreat….

[L]ike a B-movie monster, austerity will rise from the dead in 2015 and 2016 when countries have to meet their delayed fiscal targets and, in addition, implement a commitment to repay a portion of their excessive debt each year. I assume that most countries will not have fixed their banks by then, so that overall growth will probably still be low because credit conditions will still be tight. Austerity will once again be pro-cyclical…. What is happening in the eurozone is best understood at the aggregate macro level…. Prices fluctuate between countries. But it is normal for prices to rise in some countries and fall in others. As long as aggregate [eurozone] inflation is pinned down, there is no reason to be concerned about “German inflation” or “Spanish deflation”. This is all you need to know….

[F]rom a macroeconomic perspective, the eurozone is still best understood as a fiscal unit. When you jump up to that level, it is not hard to see why austerity wreaked so much damage. We know that, with interest rates near zero, fiscal multipliers become larger. It is unsurprising that a total structural fiscal adjustment of 2.2 per cent over two years should produce negative growth rates in 2012 and this year. Since there is little fiscal space for manoeuvre in the south, the only logical way for the eurozone to avoid such extreme austerity would have been for Germany to accept a fiscal stimulus…. Those who make such arguments would never dream of analysing the dynamics of the US economy purely on the basis of state-level information. But this is exactly what they do over here.

Despite its debt crisis, the eurozone behaves like a regular large, closed economy. The trouble is that it is run, and often analysed, as no more than the sum of its parts. The tragic error of the eurozone’s policy makers is to repeat this fallacy of composition again and again. It is the same with austerity. That, too, will return.