Has Economic Austerity Failed Europe?

“In the early phase of the crisis, it was essential to restore the credibility of fiscal policy in Europe, because that was fundamentally questioned by market forces,” said Olli Rehn, the European Commissioner for Economic and Monetary Affairs, according to Reuters. “There was no choice.”

Rehn’s comments strike at the heart of a debate that is currently being held not just in Europe, but in the United States, Japan, and every other economy struggling to recover from economic crisis. Broadly, policymakers have pursued one of two vectors that could lead to growth: austerity, or stimulus.

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In America, this debate is largely split along party lines. In general, the GOP favors an austere approach to budget reform, looking to cut spending dramatically, balance the budget as fast as possible, and curb the growth of government outlays. While this is a fiscally-responsible strategy, critics — here, the Democratic camp — suggest that a prolonged period of relatively high debt will not threaten long-term economic stability.

Instead, critics of austerity champion a program that focuses on growth, and growth means spending. The thinking — currently being debated at the top levels of government, academia, and finance — is that the short-term damage caused by austerity would linger painfully in mid- and long-term recovery efforts. Spending, on the other hand, can be accommodated more comfortably, even at debt loads near or above 100 percent of gross domestic product.

Europeans have faced at least three years of severe debt crisis and five consecutive quarters of shrinking economic growth through the end of 2012. Unemployment in the region has increased slowly but steadily to a recent high of 12 percent, and austerity has played a significant role in that contraction.

But following last week’s meeting of G20 economic leaders, severe austerity programs may be coming to an end. Instead, with spending at least somewhat curbed, policymakers will implement more pro-growth strategies aimed at reducing unemployment and generating some positive growth numbers for a change. Fiscal consolidation will continue to be necessary to control debt, but many short-term debt-reduction deadlines may be extended as “growth-friendly” deficit-reduction policies gain popularity.

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“Now as we have restored the credibility in the short-term, that gives us the possibility of having a smoother path of fiscal adjustment in the medium-term,” said Rehn. Jack Lew, U.S. Treasury Secretary, has said that the rush to restore credibility in the EU — largely through fiscal austerity — has negatively impacted the economic situation in some countries.

International Monetary Fund Director Christine Lagarde seems to be on board with the movement as well. Speaking about Spain in particular, she suggested that severe, short-term austerity measures could be eased and longer-term growth programs implemented in order to spur job growth.

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