LET'S GO BACK TO A KEYNESIAN APPROACH BEFORE THE BOAT SINK!

At the outbreak of the financial crisis, a consensus existed that the correct way to spur economic growth was through massive government intervention to prop up sagging demand- A Keynesian approach. However, the Greek debt crisis and continuing concerns that sovereign debt defaulst could spark throughout the eurozone have struck fear and in response European governments are now moving into fiscal retrenchment which is NOT the solution. Although a balanced budget might bring national credibiility within financial markets, fiscal austerity measures risk choking off any nascent economic recovery. Indeed, austerity measures will force unnecessary pain on the poor and most vulnerable populations. For Europe immediate austerity is NOT the answer. Rather Europe should be focused on regaining medium-term fiscal responsibility and developing long-term structural solutions.  If the goal of government policy is to restore market credibility, then comprehensive , structural solutions are far superior to short-term budget gimmicks.

John Maynard Keynes first articulated what would become the foundations of modern macroeconomics in his seminal work , 'The General Theory of Employment, Interest, and Money'. Writing during the Great Depression, Keynes theoretized that a collapse in aggregate demand is the root cause of the high unemployment and low production that accompany economic downturns.  For Keynes, the total economy's total income reflected the spending decisions of consumers, businesses and the government, and recessions were periods characterized by inadequate spending. To counteract a downturn, policymakers must make up for a lack of private sector spending through expansive monetary policy, which consists of lowering interest rates to induce investment, or expansive fiscal policy which involves either increasing government spending or cutting taxes. Both mechanisms would increase aggregate demand and allow the economy to reach an equilibrium with higher employment and overall production. However, in order to finance the spending necessary to boost aggregate demand, a country must either have sufficient revenues, or, if it faces a deficit, issue sovereign bonds instead. In a debt crisis, a collapse of investor confidence can force the indebted country to issue higher-yield bonds and face exhorbitant interest rates, often leading to a default on its sovereign debt. While some countries may remedy the problem through devaluing their currency or cutting interest rates, ascencion to the eurozone comes at the cost of monetary sovereignty.  Therefore, eurozone countries facing debt crises cannot simply inflate their way out of debt, and fiscal retrenchment becomes the only remaining remedy.

Today, despite the continued global recession the dialogue has shifted from how to spend money to promote future growth to how to spend less to avert future catastrophe.  European leaders are now extolling the virtues of fiscal austerity. Even the European Central Bank is saying that 'fiscal thrift will increase private spending by reducing uncertainty about government tax policy and debt. Deficit reduction, not stimulus spending is now the nerw solution to Europe's economic woes.

Unfortunately, the attraction of austerity will wear off as voters are faced, with the tax hikes and cuts in government services implicit in 'fiscal responsibiity'. Austerity measures will disproportionately affect those already living in poverty, despite pledges by governments not to 'balance the budgets on the back of the poor'. Aside from moral issues, government measures such as these can prompt the sort of destabilizing political unrest that only frightens investors further and impede economic growth.

The same eagerness for austerity should be transferred to an enthusiasm for sweeping structural reforms that will restore potential output, and, therefore, promote long-term growth. For Europe, that means revitilizing stagnant labour and product markets in the uncompetitive countries on the periphery of the eurozone. These supply-side reforms, coupled with a short-term boost indemand provided by fiscal stimulus are crucial to restart the worrysome decline of the European economy.