Wednesday, February 26, 2014

A note on German austerity

Over at Heritage, Salim Furth talks structural deficits. Sadly, he gets his argument backwards.
The reason Germany did not shrink its structural deficit is that Germany barely had a structural deficit! In 2009, Germany’s structural deficit was just 1 percent of gross domestic product. Greece’s deficit was 19 percent. In fact, across eurozone countries, the change in structural balance from 2009 to 2012 is largely predicted by the size of 2009 deficits—the bigger the deficit, the harder they fell.

That’s a problem for the Keynesian story. According to Krugman’s Keynesian model, government can stimulate aggregate demand by running large deficits in bad times, softening the recession. If government fails in its duty to borrow, the recession will mire on.


What did the Germans do that put them in a position for growth right after the recession? Back in 2001, Germany and Greece had the same structural deficit—just above 3 percent. But Germany shrank its deficit from 2004 to 2008 by cutting spending on welfare, unemployment insurance, and pensions.

Um. Okay. Furth takes data from the latest IMF World Economic Outlook Database. What does the database say about economic growth in these countries over this period? From 2002 to 2009, German output increased 4.7 percent per capita. (That’s only 0.7 percent per year!) By contrast, the Greek economy grew more than three times as fast, per capita (16.3 percent, or 2.2 percent per year.)

So the big-deficit Greeks enjoyed much faster growth than the austere Germans. Now, perhaps Furth might argue the Greek growth was unsustainable on account of all that borrowing, requiring the Greeks to reverse course at the worst possible time. But that hardly represents anything like “a problem for the Keynesian story.”

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