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Economics and Politics by Paul Krugman - The Conscience of a Liberal - NYTimes.com

Wolfgang Munchau suggests a reason for European misjudgements -- he argues that European leaders have failed to take account of the fact that Europe, collectively, is a fairly closed economy, selling primarily to itself:

The many failures of the eurozone's crisis response policy have a common cause: the eurozone is a large closed economy. Each of its 17 members is small and open. The political leaders who run the eurozone have a small open economy mindset - every one of them, without exception. The economists they employ mostly use small, open economy models.

It's an interesting thesis, and I agree that the within-Europe spillovers from fiscal austerity are significant. Early on in the crisis I did some back-of-the-envelope calculations for fiscal expansion and guesstimated that a coordinated expansion had twice the bang per euro of a unilateral expansion by just one euro area economy. By the same logic, austerity would look much more attractive to each individual country if they don't take the cross-border effects into account.

That said, I think Munchau is being too kind here. European leaders and institutions by and large didn't even get to the point of devising policies that might have worked in a small open economy. Instead, they went in for fantasy economics, believing that the confidence fairy would make fiscal contraction expansionary. The ECB, which Munchau credits as the institution most aware of the linkages, was also the institution most dedicated to the doctrine of expansionary austerity.

by Nomad on Mon Oct 17th, 2011 at 05:10:39 PM EST
[ Parent ]
There's a doctrine of expansionary austerity?

Like - fer real?

(And expansionary for who?)

by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Oct 18th, 2011 at 04:30:04 AM EST
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Yes, it's a doctrine.

At least it's been preached by the European political and economic elites for two years now...

Economics is politics by other means

by Migeru (migeru at eurotrib dot com) on Tue Oct 18th, 2011 at 04:32:44 AM EST
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Münchau's FT piece contains a reference to this IMF working paper: Expansionary Austerity: New International Evidence
Summary: This paper investigates the short-term effects of fiscal consolidation on economic activity in OECD economies. We examine the historical record, including Budget Speeches and IMF documents, to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to prospective economic conditions. Using this new dataset, our estimates suggest fiscal consolidation has contractionary effects on private domestic demand and GDP. By contrast, estimates based on conventional measures of the fiscal policy stance used in the literature support the expansionary fiscal contractions hypothesis but appear to be biased toward overstating expansionary effects.
(My emphasis)

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Tue Oct 18th, 2011 at 04:44:16 AM EST
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Nnnng?

I suppose it's cause for optimism that some small hints of daylight seem to be creeping into the religious rhetoric.

But. Still.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Tue Oct 18th, 2011 at 06:52:11 AM EST
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Yes. It's a kissing cousin of the doctrine that says that everybody should be a net exporter.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Oct 18th, 2011 at 08:19:50 AM EST
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Münchau's "small open economy mindset".

Economics is politics by other means
by Migeru (migeru at eurotrib dot com) on Tue Oct 18th, 2011 at 08:35:22 AM EST
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yes it expands the elite's wallets, and they would like to expand its therapeutic regime.

expansionary, see?

the affect on the economy is contractionary, but they don't get any brownie points for telling us that.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Tue Oct 18th, 2011 at 03:19:31 PM EST
[ Parent ]

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