Paul Krugman has an interesting blog on the New York Times website on austerity and growth in the eurozone. I thought it would be interesting to examine the question, using the latest data from the International Monetary Fund’s World Economic Outlook database.
I have defined the fiscal tightening as the percentage point change in the structural (or cyclically-adjusted) general government deficit from 2008, the year of the crisis, to the forecast for 2012. The assumption is that this change represents the results of policy, rather then cyclical effects. I have taken growth as being the proportional change in GDP from 2008 to 2012.
The result is below. It is what I would have expected: the bigger the structural tightening, the larger the fall in GDP. The estimated fit is fairly good for this sort of calculation. Every percentage point of structural fiscal tightening is estimated to lower GDP by 1.5 per cent of its 2008 level. So the 8 percentage points of structural fiscal tightening in Greece lowered its GDP by 12 per cent.
Apart from the support this calculation gives to those who think austerity is contractionary, at least in current conditions, what else does it tell us about this relationship?
- First, the economies of Malta, France and Germany seem to be surprises: they have grown, despite fiscal contractions. But fiscal contraction of France and Germany is small and their growth is small, too. These are not significant surprises.
- Second, the economies of the Netherlands and Finland have contracted modestly, despite modest fiscal loosening. These are also modest surprises.
In all, then, of the fifteen countries, only five show a surprising relationship between fiscal tightening and economic growth and all but one of these (Malta) are only small surprises.
I would add that the fiscal contractions in Greece and Ireland have been very large indeed. It is no surprise that these economies have contracted sharply.
In all, there is no evidence here that large fiscal contractions bring benefits to confidence and growth that offset the direct effects of the contractions. They bring exactly what one would expect: small contractions bring recessions and big contractions bring depressions.
Moreover, the cumulative performance of eurozone economies between 2008 and 2012 is poor. Only six economies are forecast to grow at all: Austria; Belgium; France; Germany; Malta; and the Slovak Republic
Finally, since a large number of countries are expected to tighten their fiscal positions substantially in coming years, their economies are likely to contract. How long the political glue will hold in these circumstances is a really interesting question.
