Budget cuts in the Euro area

Discussion in 'Europe' started by Sheldon, Jun 14, 2010.

  1. Sheldon

    Sheldon Senior Member

    Apr 2, 2010
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    ...On June 8th Germany’s government announced a package of measures that will save it around €80 billion by 2014. Its chancellor, Angela Merkel, said Germany should set an example of budgetary discipline to other euro-zone countries. France has also said it will act to trim its deficit by abolishing tax exemptions and freezing most spending programmes from next year. This rush to don the hair-shirt raises a fresh concern: if budget cuts are too severe, might they push the economy back into recession, defeating their purpose?


    There is much uncertainty about the economic impact of fiscal tightening, not least because some temporary measures will also have run their course by next year. Budget cuts weaken GDP growth by shrinking aggregate demand. The simplest gauges of such “Keynesian” effects suggest that each euro of lost public spending reduces GDP by around the same amount.

    But in some circumstances budget cuts can help growth—or cause less harm to it than Keynesian models suggest. Firm action to tackle budget deficits may induce anxious consumers to save less (and firms to invest more) by lowering uncertainty about future tax changes. Such anxiety is likely to be bigger when public debts are worryingly high because taxpayers judge that the need to reduce the deficit will soon hurt their finances. Research by Christiane Nickel and Isabel Vansteenkiste of the European Central Bank found that rising budget deficits in high-debt countries are associated with higher private savings.

    A lot also depends on how budgets are cut. A much-cited study by Alberto Alesina of Harvard University and Roberto Perotti, now of Milan’s Bocconi University, found that budget adjustments that rely on cuts in welfare payments or the government’s wage bill are more likely to produce lasting benefits—lower public debt and faster GDP growth—than those based on tax increases or cuts in public investment. The least harmful taxes were on firms’ profits or on consumer spending.

    Budget cuts in the euro area: Nip and tuck | The Economist

    Our government in America could do well to pay attention to what's going on in Europe right now.

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