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Do we need more or less fiscal austerity in the eurozone?

Publishing date
08 February 2012

Do we need more or less fiscal austerity in the eurozone? The answer is simple: it depends on the country and its economic circumstances.

Let's first do away with some fairy tales. No: fiscal consolidations are not expansionary. The few studies that claim to prove expansionary fiscal consolidations typically relate to very specific circumstances with strong external growth and exchange rate adjustments. All these conditions are not in place in the euro area. But also no: from an economic point of view, fiscal consolidations cannot be self-defeating. A reduction of public spending will typically result in a reduction in GDP but an even greater reduction in debt. At any reasonable multiplier, the deficit to GDP as well as the debt to GDP ratio will be lower compared to the case of no fiscal consolidation. Expenditure cuts thus do reduce fiscal vulnerability and are not self-defeating.

So should countries that are in a recession and face market pressure always enact a fiscal consolidation? That essentially depends on three things.

First, is the external borrowing position of the country sustainable? In the case of Greece, the current account deficit of almost 10% in 2011 suggests that domestic demand is still excessive and further cuts seem unavoidable. Avoiding fiscal consolidations will only sustain excessive demand and increase borrowing from abroad leading to more political and market pressure.

Second, does the economy have the capacity to grow externally? Again, the absence of significant price adjustments in Greece suggests that export growth is unlikely to pick up soon.

Replacing the external demand with internal demand created by large fiscal deficits will only delay the adjustment and increase the dependence of Greece on external funding.

Third, there is a social dimension. Fiscal cuts hurt people and lead to unemployment. If such cuts render the ability to reform the country impossible, it may be preferable to delay fiscal adjustment, a point made by my colleague Jean. But we should push this argument further:

Ultimately it means that fiscal transfers may be needed in monetary union if political, social and economic stability is the highest priority. Fiscal union is still incomplete. The situation is certainly different in every country of the euro area.

About the authors

  • Guntram B. Wolff

    Guntram Wolff was the Director of Bruegel. Over his career, he has contributed to research on European political economy and governance, fiscal, monetary and financial policy, climate change and geoeconomics. Under his leadership, Bruegel has been regularly ranked among the top global think tanks and has grown in influence and impact with a team of now almost 40 recognized scholars and around 65 total staff. Bruegel is also recognized for its outstanding transparency.

    A recognized thought leader and academic, he regularly testifies at the European Finance Ministers' ECOFIN meeting, the European Parliament, the German Parliament (Bundestag) and the French Parliament (Assemblée Nationale). From 2012-16, he was a member of the French prime minister's Conseil d'Analyse Economique. In 2018, then IMF managing director Christine Lagarde appointed him to the external advisory group on surveillance to review the Fund’s priorities. In 2021, he was appointed to the G20 high level independent panel on pandemic prevention, preparedness and response. He is also a professor (part-time) at the Solvay Brussels School of Université Libre de Bruxelles, where he teaches economics of European integration.

    He joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he was coordinating the research team on fiscal policy at Deutsche Bundesbank. He also worked as an external adviser to the International Monetary Fund.

    He holds a PhD in economics from the University of Bonn and studied in Bonn, Toulouse, Pittsburgh and Passau. He taught economics at the University of Pittsburgh and at Université libre de Bruxelles. He has published numerous papers in leading academic journals. His columns and policy work are published and cited in leading international media and policy outlets. Guntram is fluent in German, English, French and has good notions of Bulgarian and Spanish.

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