Saturday, April 6, 2013
Austerity Might be Expansionary in the Eurozone
Or at least not contractionary. I've been thinking about the fiscal situation in Europe, and how Keynesian critics of Eurozone policies advocate that government swear off austerity in favor of spending to boost the economy. According to standard Keynesian theory, when interest rates are up against the zero lower bound, monetary policy has no traction and fiscal policy has no opportunity cost because interest rates don't rise to crowd out private investment spending. As a result, countries like Spain and Italy should keep running budget deficits despite fiscal concerns, to support the fledgeling economy. Here's the problem:
Krugman makes this point all the time, saying that deficit spending for the US economy is only appropriate in a liquidity trap with zero interest rates. But I guess the rules are different in Europe.