IMF Admits That the West Is Stuck in Near Depression

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The IMF report
– "Will It Hurt? Macroeconomic Effects of Fiscal Consolidation"
– implicitly argues that austerity will do more damage than
so far admitted.

Normally, tightening
of 1pc of GDP in one country leads to a 0.5pc loss of growth after
two years. It is another story when half the globe is in trouble
and tightening in lockstep. Lost growth would be double if interest
rates are already zero, and if everybody cuts spending at once.

"Not all
countries can reduce the value of their currency and increase net
exports at the same time," it said. Nobel economist Joe Stiglitz
goes further, warning that damn may break altogether in parts of
Europe, setting off a "death spiral".

The Fund said
damage also doubles for states that cannot cut rates or devalue
– think Spain, Portugal, Ireland, Greece, and Italy, all trapped
in EMU at overvalued exchange rates.

"A fall
in the value of the currency plays a key role in softening the impact.
The result is consistent with standard Mundell-Fleming theory that
fiscal multipliers are larger in economies with fixed exchange rate
regimes." Exactly.

Let us avoid
the crude claim that spending cuts in a slump are wicked or self-defeating.
Britain did exactly that after leaving the Gold Standard in 1931,
and the ERM in 1992, both times with success. A liberated Bank of
England was able to cut interest rates. Sterling fell. The key point
is whether you can offset the budget cuts.

But by the
same token, it is fallacious to cite the austerity cures of Canada,
and Scandinavia in the 1990s – as the European Central Bank
does – as evidence that budget cuts pave the way for recovery.
These countries were able export to a booming world. They could
lower interest rates, and were small enough to carry out `beggar-thy-neighbour’
devaluations without attracting much notice. We were not then in
our New World Order of "currency wars".

Be that as
it may, it is clear that Southern Europe will not recover for a
long time. Portuguese premier Jose Socrates has just unveiled his
latest austerity package. He has capitulated on wage cuts. There
will be a rise in VAT from 21pc to 23pc, and a freeze in pensions
and projects. The trade unions have called a general strike for
next month.

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the rest of the article

October
5, 2010

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