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Growth vs austerity conundrum: no simple answer

Fierce debate is raging in Europe over whether austerity or growth offers the best strategy to overcome the continent’s sovereign debt crisis. As if it were that simple.

business Updated: Apr 16, 2012 23:51 IST

Fierce debate is raging in Europe over whether austerity or growth offers the best strategy to overcome the continent’s sovereign debt crisis. As if it were that simple.

As the euro zone hovers on the brink of its second recession in three years, the battle launched in academic journals, blogs and the financial press has spread to the hustings in France, Greece and soon in Germany too.

“Europe can’t cut and grow,” Sony Kapoor, head of the Re-Define think-tank, and Peter Bofinger, a member of the German Council of Economic Advisers, said in an article before European Union leaders adopted a budget discipline pact last month.

“The EU needs a growth compact, not a fiscal one. Swift action on tax and jobs is the way out of the crisis.”

The growth camp argues that synchronised austerity across Europe will only aggravate economic contraction, swell the ranks of the unemployed and make it harder for debt-laden countries to reduce their deficits and restore market confidence.

Less government spending reduces public sector jobs and shrinks demand, depressing consumer spending and investment, and risks pushing the economy into a self-defeating vicious cycle.

“The question is whether governments should relent in their efforts to reduce deficits now, when the global economy is still weak,” economist Giancarlo Corsetti said in a debate on the VoxEU website.

The austerity crowd contend that cutting spending is vital to make public finances sustainable, build credibility with investors and create conditions for healthy growth that is not based on ever more borrowing or on real estate bubbles.

“It would be very easy to lose the credibility we have built with fiscal consolidation,” said a senior EU policymaker, speaking on condition of anonymity.