Global policy makers and economists are staging a retrial of austerity as new evidence arises.
Facing another slowdown in the world economy, the U.S. and International Monetary Fund are pitched against the euro area and U.K. over whether axing budgets and debt is the recipe for recovery or recession. In academia, professors Kenneth Rogoff and Paul Krugman remain at odds.
The dispute, which led to finger-pointing and a fight over setting new debt targets at weekend talks of finance chiefs in Washington, is getting a re-airing as economic data from the U.S. to Europe undershoot estimates. Research co-written by Rogoff that has been used to justify cuts has come under scrutiny.
“Delaying necessary adjustments would further aggravate risks for the prospects of a lasting and fundamentally sound global recovery,” German Finance Minister Wolfgang Schaeuble told the fund’s 188 member nations. IMF Managing Director Christine Lagarde told Bloomberg Television that “for some of them there’s no reason to rush into up-front, heavily loaded fiscal consolidation.”
Data this week from U.S. durable goods purchases to the strength of European manufacturing may show the pain of tighter fiscal policy as recession-hit European governments keep cutting to defeat their debt woes and the U.S. deploys across-the-board federal spending cuts, called sequestration. The Standard & Poor’s 500 Index is up more than 9 percent this year, while the Euro Stoxx 50 Index is down more than 2 percent.
Agreeing that “much more is needed” to reinforce what they called a “weak” world economy, Group of 20 finance ministers and central bankers still proved unable to bridge ideological differences over budgets. A discussion over debt targets ended with a promise to revisit how to replace 2010 goals most failed to meet before scrapping last year.
A U.S. Treasury official, speaking to reporters after the meeting, said that the U.S. wanted to avoid hard targets and convinced participants to keep the focus on addressing issues such as unemployment in parts of Europe rather than setting fiscal benchmarks.
Still suffering from more than three years of debt turmoil, the Europeans defended their push to rein in fiscal positions, arguing that even with 19 million unemployed it would eventually prove the best route to recovery and that they were showing greater flexibility than realized.
Schaeuble used the meeting to promote “growth friendly” deficit-reduction policies he’s pursued at home. His boss, Chancellor Angela Merkel, last week said “we always talk about austerity -- that’s the new word that’s often used -- but forget that we never talk about the fact that we have to pay back debt.”
European Union Economic and Monetary Affairs Commissioner Olli Rehn told Bloomberg Television in Washington that the region “will have to continue fiscal consolidation because the debt levels have increased significantly.” Other measures were focused on lifting growth and job creation, he said.
Even as Fitch Ratings cited the U.K.’s fiscal outlook in stripping it of its top credit grade, Chancellor of the Exchequer George Osborne similarly rejected pleas from the IMF to ease up. “We are demonstrating credibility and flexibility,” he said ahead of data predicted to show his economy just skirted a triple-dip recession.
The counter argument, as presented by the IMF in a reversal from its austerity prescriptions of the 1990s, is economies should be wary of cutting back too fast for fear it will backfire in even weaker economic growth and higher debts.
“It’s a question of how much and how quickly,” Lagarde said.
That view is shared by U.S. Treasury Secretary Jacob J. Lew. Making his G-20 debut, he said stronger European demand is “critical to global growth” and signaled countries with trade surpluses such as Germany should do more to ease “austerity fatigue” elsewhere.
In the case of the U.S., it is committed to “bringing our deficits down to a sustainable level while building a foundation to promote economic growth,” Lew said.
European officials found fault in the U.S.’s approach. European Investment Bank President Werner Hoyer said the “inability to arrive at decisions and reforms is much worse in America than it is in Europe.” Swedish Finance Minister Anders Borg said the fiscal deficits of the U.S. and Japan are “a source of concern and uncertainty.”
The divide may be narrower than the rhetoric suggests. The IMF has pushed cash-strapped countries in Europe’s periphery to make deep fiscal cuts. Estimates it released last week also showed spending restraint is slowing in Europe and speeding up in the U.S.
The Washington-based lender estimates the U.S.’s fiscal deficit will fall two percentage points to 6.5 percent of gross domestic product this year. By contrast, the euro-area’s deficit will shrink by 0.7 percentage point to 2.9 percent.
Dutch Finance Minister Jeroen Dijsselbloem, who leads the euro-area finance ministers group, said there is a “misunderstanding” that Europe is “only fixated on austerity.” Rather, it “can and will” adjust the speed of deficit reduction, he said, noting as an example that Portugal may get longer to meet its bailout terms.
French Finance Minister Pierre Moscovici went further, saying on Bloomberg Television that “it would not be reasonable to go further into austerity” and “people cannot stand it anymore.”
As for the U.S., the IMF still wants it to better outline how to taper its debt trajectory. Its sequestration is also creating the “opposite of optimal” policy because the country lacks both the short-term fillip and medium-term retrenchment it needs, said Nouriel Roubini, co-founder of Roubini Global Economics LLC in New York.
The austerity debate is restarting in academia, too. On one side, economists such as Harvard University’s Rogoff and Carmen Reinhart have long warned outsized debt can brake growth. On the other, Nobel laureate Krugman and former U.S. Treasury Secretary Lawrence Summers are among those saying tackling many fiscal holes can be delayed until economies are stronger and the immediate focus should be on expansion.
Fresh tension was injected last week after economists at the University of Massachusetts at Amherst published a study critiquing a 2010 paper written by Reinhart and Rogoff which highlighted an association between measurably slower economic growth and public debt beyond 90 percent of GDP. Both Rehn and Osborne have cited the research to justify their strategies.
While Reinhart and Rogoff acknowledged inadvertently leaving some data out of their calculations, they said it didn’t change the basic findings. Krugman used his April 19 New York Times column to say the episode shows “the extent to which austerity has been sold on false pretenses.”
“Everyone feels the austerity die is cast,” said Adam Posen, president of the Peterson Institute for International Economics and a former U.K. central banker. “I don’t see the differences changing much.”