Countercyclical no More
Browsing national accounts may be an inexhaustible source of insight on the current debate about austerity. Take this figure, which shows the evolution of real GDP and of its components for the US and the EMU, making the first quarter of 2008 equal to 100.
I tracked in particular the evolution of private (consumption plus investment) and public expenditure on good and services.
One can distinguish two phases. During the first, 2008-09, the EMU is in synch with the US (and with most other advanced economies): private expenditure falls dramatically as the crisis spills from the financial sector to the real economy; and governments gradually build up a classic Keynesian response, reaching its climax with the stimulus plans implemented in 2009. But the interesting part is the second phase. The figure shows that from the beginning of 2010 the crisis went local. While private expenditure picked up in the US, it kept falling in the eurozone. The Greek crisis and the eurozone response have been depressing the confidence of households and firms.
Looking then at public purchases of goods and services, one may be tempted to say that austerity was much harsher in the United States than in the EMU. The temptation should be resisted. First, because in a few small countries in Europe the drop in public spending was dramatic, and it simply does not show in aggregate figures because of their size. Second, and most important, because the reduction of public demand in the US accompanied the increase of private expenditure. In other words, the United States government fully played the role of supporting aggregate demand when needed, and withdrew only when private demand gained momentum. That is a What-Keynes-Would-Have-Really-Done countercyclical fiscal policy. I would argue that, because of the exceptional levels of unemployment, and of the ineffectiveness of monetary policy at the zero lower bound, the fiscal stance should have remained more expansionary throughout the years 2010-12. It remains nevertheless true that the fiscal contraction in the US only begun once the private sector showed at least some capacity to walk alone.
In the EMU, public purchases of goods and services should have continued to increase to compensate the continuing reduction of private spending; but this did not happen, with the result that fiscal policy ended up being countercyclical. The table below is an apt summary of the discussion so far; it shows the correlation between public and private expenditure in the two periods. Roughly speaking (correlation does not imply causation, ask Reinhart and Rogoff for details), a negative correlation indicates that fiscal policy may have been countercyclical.
|Correlation Between Public and Private Expenditure|
In the US the correlation is negative in both periods. Public spending increased when consumption and investment were falling (2008-09), and decreased when the trend in private expenditure was reversed. In the eurozone, since 2010, private and public expenditure have been moving in the same direction, yielding a positive correlation coefficient. This table alone explains a good deal of why the EMU economy “decoupled” from the rest of the world, and has been flirting with recession since then.
There is more than that. The (mis)management of the eurozone crisis has exposed all the flaws of the single currency while showing an astounding lack of solidarity among member countries, and not indicating any clear solution for the future. The only clear indication has been the stubborn insistence on an austerity that is proving self defeating. This certainly had a negative impact on private sector’s confidence, and contributed to depress its demand.
And still no turning point in sight…