Can austerity programs make economies grow? A fierce debate is going on, starting with a study by Alberto Alesina. Now, he replies to his critics. To me, Alesina sounds softer. He attacks Paul Krugman, but he admits that spending cuts might reduce growth in the short run if they are badly executed – while still stressing that they were the only way to get government debt down.
„Fazit“ is the economics and finance blog of the German national newspaper Frankfurter Allgemeine Zeitung. Occasionally, we publish blog posts in English. You can find our English posts at http://www.fazitblog.de/english. An RSS feed is available at www.fazitblog.de/english/rss. And please follow our English Twitter account @Fazit_Blog.
Should debt-stricken governments cut their spending? Should they raise taxes? Or will such measures kill growth and make everything worse? There is a fierce debate going on. The current discussion started with an influential paper by Harvard economists Alberto Alesina and Silvia Ardagna. Their study was taken for evidence by many journalists and politicians that countries grow faster if governments cut their spending. Spending cuts became a standard proposal for the debt-stricken countries in Europe.
Soon, three IMF researchers called this into question. Put simply, they said: Alesina/Ardagna’s selection of countries had a bias that made growth seem larger than it actually is. Christina and David Romer have a different way of dealing with the data (unguarded access here). Paul Krugman called the paper „deeply flawed“, the examples „bad“. Not too long ago, Christina Romer again attacked Alberto Alesina. In Germany, our F.A.Z. Sunday paper and Zeit’s blog „Herdentrieb“ joined the debate (both links are in German). Alesina himself took up some technical issues on his website. Bocconi economist Roberto Perotti also stroke back and criticized the IMF method.
So I asked Alberto Alesina about his views in a short telephone interview. He is angry at Krugman. „Paul Krugman is the perfect example of somebody who creates a strawman of a paper to attack it and thereby make a point he wants to make, which is every country should increase spending, no matter what, including Greece“, Alesina says. „My paper has never claimed that every fiscal adjustment is expansionary. It just claimed that there have been examples in which some well-designed policy packages, based on spending cuts and other measures, have been associated with a positive impact on the economy.“ He points to Finland and Sweden in the mid-90s as well as Canada. „The question is when you take an average of all the fiscal adjustments that ever occurred, whether the average is expansionary or recessionary.“
Today, Alesina sounds softer to me than he did when the paper had just been published. In a VoxEU post by Alesina et al., the authors wrote: „More often than not spending cuts boost growth even in the very short run.“ Today, Alesina says that „a well executed package of spending cuts can be done without going into a recession. This is what I believe the evidence about historical experience says“. The paper itself, however, contains neither of these claims, if read carefully. Alesina and Ardagna do not explicitly stress that they only deal with some examples. But they do not explicitly conclude that spending cuts are expansionary either. In fact, they deal with a different question. They ask: „Is raising taxes or cutting spending more likely to result in a stable fiscal outlook?“ And their answer is: „Our results suggest that tax cuts are more expansionary than spending increases in the cases of a fiscal stimulus“. This is only a relative comparison and tells nothing about expansionary effects of spending cuts in general.
In our phone interview, Alesina did not regard his paper as a policy guide for heavily indebted countries such as the US and the Eurozone countries. „Some people have read the paper and said: Therefore fiscal adjustment today is expansionary. They may be right or wrong, I don’t know, the paper makes absolutely no claim about this“, he says. Alesina sees several factors which make fiscal adjustments harder:
* After banking crises, recovery is very slow even before fiscal adjustment starts.
* There are many countries which have to do fiscal adjustments at once.
* Within the Euro zone, countries cannot devaluate their currency.
But he also sees factors which make fiscal adjustments easier:
* Labor market reforms, which achieve wage moderation, are still possible in most countries.
* Monetary policy can help: „I am afraid that the ECB will have to continue to be very dovish, because that is the only way out.“
What remains for current policy? Alesina thinks there is only little debate about two points: „The only way to really achieve a stabilization of the debt to GDP ratio is to stop the growth of spending. If you don’t stop the growth of certain automatic spending like pensions and health, you won’t reduce deficit in the long run“, he says. And: „In OECD countries, where the tax rate is already very high and government spending is close to 50 percent of GDP, spending cuts are less recessionary than raising taxes.“ These are the points about which Alesina sees a consensus.
But I don’t think that the debate will be finished now. So who’s next?
Please do post your comments in English.