The Eurozone Doomsday Machine of Austerity

Interesting perspective on the effect of fiscal contraction in the eurozone by Econbrowser. I guess it makes sense. If the multiplier at the zero bound is high for positive spending it should be equally high (with a negative sign) if fiscal spending is cut back. The only issue is obviously that most of the Southern European economies are, in my book, fundamentally insolvent and thus the end solution is somewhat different than just cranking up fiscal spending, but monetisation of fiscal deficits will inevitably be part of the solution if this continues.

The logic is as follows. The standard multiplier assumes each country can be treated as a relatively small open economy, where decreases in output induce decreases in imports, which offset the initial decline. However, when all countries are simultaneously shrinking, then the decline in imports is in turn mitigated.Thinking about the eurozone in terms of individual countries highlights the fact even if some countries are constrained by borrowing costs (compare against the US Federal government with current real funding rates of zero), Germany and other northern European could stimulate their economies. This would help brake the continent’s contractionary spiral.

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