growth, austerityThis is a question every (non-emerging) economy around the world with the exception of Luxembourg must be asking itself: Is economic growth possible in a context of fiscal consolidation? If so, HOW?
Initially Europe focused on austerity but now they seem keen on focusing (more?) on growth.
Most of what I’ve read and thought about points to export-led growth, but all developed countries can’t pursue this strategy … and emerging markets can’t yet buy all this stuff.
Another strategy is the structural reforms agenda to boost multifactor productivity … but that takes forever.
In a purely Keynesian world fiscal consolidation is compatible with recovery as long as monetary policy can pick up the slack.
It’s an open question whether central banks can accomplish anything at 0 interest rate. Sweden did achieve negative interest rates with great success, US experimented repeatedly with new monetary tools while ECB prefers to just sit by and see Greeks suffer.
If you meant long-term growth, then austerity is perfectly compatible. Take UK debt: http://www.ifs.org.uk/bns/bn26.pdf it dropped from 200% to 50% from 1945 in spite of tremendous growth.
Let’s assume a completely closed economy, gold standard (no fiat money). Is growth possible under these circumstances? Assume also no gold extraction.
Y*P=M*V
Since M (money supply) is stable, the only possibility for growth, ceteris paribus, is that the Velocity of Gold increases, but since there is a limiting (physical) factor that limits the growth of V, it follows that the only possibility of Y to increase is for P to decrease.
This leads to answering your question: If Fiscal stimuli (budget deficit) is accompanied with an increase in the Money Supply (M) we’d have either Y or P or a combination of both increase.
IF, however, the central bank does nothing and allows the interest rates to increase then NOTHING happens it’s just the structure of what and for whom is produced is changed.
On the other hand, I believe that the Central Bank has VERY limited ability to increase the money supply IF it operates through giving loans (because loans, even with a low interest rate, need be RETURNED). Therefore, the only increase in the Money supply that is needed to counteract the deflationary process is by running a small budget deficit and the CB buying it. However, this too is not a solution because once you allow for such things, politicians will overshoot the money supply target and create hyper-inflation.
What do you actually mean with fiscal consolidation? Gov Revenue = Gov Expenses? If so, imagine a closed economy, and no growth of money supply. Is NOMINAL growth of GDP possible if the velocity of money is constant? I think not. That’s why I used the QTM model above.
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