Perverse Fiscal Consolidation

Between 2011-2013 IMF documents and research papers have revised upwards earlier estimates of fiscal multipliers, which throughout 1970-2009 were assumed by the IMF and other international organisations to be on average about 0.5 for advanced countries (Blanchard and Leigh 2012, 2013, Batini et al. 2012, Cottarelli and Jaramillo 2012 and other researchers associated with the IMF).

The upward revision applies from 2010 and was justified by: the ineffectiveness of countervailing monetary expansion close to the zero floor of the interest rate, lack of opportunities for exchange rate devaluation especially in the Euroarea, by a large gap between potential and actual income (for fiscal multipliers are higher in a downturn than in a boom); and by simultaneous recent consolidation across countries.  Moreover, the fiscal multiplier for expenditure cuts – contrary to earlier claims - turns out to be much (up to ten times) higher than for tax rises.

This means that fiscal consolidation is more expensive in terms of output loss than previously believed.  But there is worse: the higher are fiscal multipliers, the higher is the probability that fiscal consolidation will have the perverse effect of actually raising the Public Debt/GDP ratio. 

Namely:  a fiscal consolidation (tax increases plus government expenditure cuts) will always necessarily result in an increase instead of a decrease of the Public Debt/GDP ratio, with respect to what that ratio would have been in the absence of fiscal consolidation, as long as the fiscal multiplier – or more precisely the weighted average of fiscal multipliers applicable to the composition of the fiscal package – is greater than the inverse of the country’s Public Debt/GDP ratio. Thus in such circumstances fiscal consolidation, contrary to received wisdom, will make Public Debt more rather than less costly to re-finance, and therefore less instead of more sustainable. In plain words, fiscal consolidation works only in those countries that, having a sufficiently low Public Debt/ratio, do not actually need a consolidation.

Here is the proof. Given D=Public Debt, Y=GDP, d=D/Y, x=the size of fiscal consolidation (tax rises plus expenditure cuts of given composition) expressed as a share of GDP, 

ΔD=-xY

ΔY= -mxY

where m is the appropriate fiscal multiplier,

Δ(D/Y) = [(ΔD)Y – (ΔY)D]/Y² = 

= [(-xY)Y – (-mxY)D]/Y²

= -x Y²/Y² + mxY D/Y² =

= -x + mxD/Y = mxd – x  and therefore                 

Δ(D/Y) = x(md – 1) = xd(m – 1/d)

from which we can see that the ratio D/Y must increase,
i.e. Δ(D/Y) >0,  if and only if m>1/d.  Q.E.D.

The interest of this proposition is in the fact that the inverse of the D/Y ratio is naturally all the smaller the more heavily indebted a country is, and particularly small with respect to the kind of fiscal multipliers estimates that have been produced in recent literature (such as Blanchard and Leigh 2012, 2013, Batini et al. 2012, Cottarelli and Jaramillo 2012 and other researchers associated with the IMF). Thus the counterproductive nature of fiscal consolidation in advanced economies, especially in highly indebted countries with high fiscal multipliers, is an absolute certainty.   

Figure 1. Illustration of perverse fiscal consolidation raising the Public Debt/GDP ratio (CLICK TO ENLARGE): Δ(D/Y) >0 for plausible values of m and as an increasing function of D/Y. 

The figure above (for which I am indebted to my colleague Marilena Giannetti) illustrates the impact of a fiscal stabilisation package of 5% of GDP, relatively modest by the standards of the current crisis, on the Public Debt/GDP ratio, Δ(D/Y)= x(md – 1), as a function of the current d=D/Y ranging from 50% to over 200% of GDP and for alternative values of fiscal multipliers ranging from 0.5 to 3.5.  At high D/Y ratios and relatively high multipliers still within the range estimated by recent IMF sources, the rise in D/Y can be devastating. 

By way of example, a country with d=1.20, m=3, undertaking a stabilisation of x=5%, would raise its d by 0.05*(1.20*3-1)=13% of GDP, from 1.20 to 1.33.  In a country like Japan, for a Public Debt at over 200% of GDP, a fiscal consolidation package of 5% would lead to an increase of the Public Debt/GDP ratio of the order of 30% of GDP. For a perverse effect of fiscal consolidation on such a massive scale the claim that “The short-term effects of fiscal policy on economic activity are only one of the many factors that need to be considered in determining the appropriate pace of fiscal consolidation for any single economy” (Blanchard and Leigh, 2013, p.6) is facile and disingenuous. Such a regime switch cannot be ignored.

Table 1. Threshold of the fiscal multiplier over which fiscal consolidation necessarily leads to higher Public Debt/GDP ratio for selected countries (calculated as the GDP/Public Debt ratio, from the data estimated by US-CIA, The World Factbook, 2013, for 2012), ranked by increasing value of the multiplier threshold.

Country    Public Debt/GDP      GDP/Public Debt

Japan            214.3                        0.47
Greece          161.3                        0.62
Ireland          118.0                        0.84
Italy              126.1                        0.79
France             89.9                        1.11
UK                  88.7                        1.13
Spain              85.3                        1.17
Germany         81.7                        1.22
Hungary          78.6                        1.27
Austria            74.6                        1.34
US                  73.6                        1.36
Netherland       68.7                       1.45
World  average 64.0                       1.56
Albania            60.6                       1.65
Poland             53.8                       1.85
Finland            53.5                       1.87
Slovakia          48.6                       2.06
Czechoslovakia 43.9                       2.21
Denmark         45.3                        2.21
Sweden           38.6                        2.56
Romania          37.2                        2.69

We have seen above that before the crisis the value of fiscal multipliers generally assumed by the IMF for advanced economies for forty years (1970-2009) was on average 0.5.

This leads to the presumption that – if national fiscal multipliers were all identical to the group average of 0.5 – only in Japan (with a GDP/Public Debt ratio as low as 0.47 in 2012 and 0.43 in 2013) would fiscal consolidation have raised the Public Debt/GDP ratio, and only very marginally at that. In all other countries fiscal consolidation would have worked, lowering both D and the D/Y ratio. 

The lower bound of the fiscal multipliers revised by Blanchard and Leigh (2012 and 2013), at 0.9, would imply a perverse consolidation pattern in 2012 not only in Japan but also in Greece, Ireland and Italy; while the upper bound of 1.7 would add to the list of perverse consolidation also France, the UK, Spain, Germany, Hungary, Austria, the US, the Netherlands and Albania.

The lower bound of the expenditure multipliers estimated by Batini et al. (2012), 1.6, would remove only Albania from the list of perverse fiscal consolidation, but its higher bound 2.6 would include – in addition to the previous list, also Poland, Finland, Slovakia, the Czech Republic, Denmark and Sweden, leaving out Romania as the only country in table 1 in which consolidation would not raise the Public Debt/GDP ratio and reduce GDP growth.  Using the range of estimated multipliers for tax rises, 0.16-0.35, on the contrary, that kind of fiscal consolidation would always work, i.e. would reduce both the absolute level of Public Debt and its ratio to GDP.

For the multiplier estimated by Auerbach-Gorodnichenko (2012b), near zero in normal times to about 2.5 during recessions, fiscal consolidation would work always in a boom, and never in a recession except in Sweden and Romania.  Finally, for Christiano et al. (2011), with the multiplier at 3.2 once the interest rate approaches the zero interest lower bound, all the countries in Table 1 would experience perverse fiscal consolidation. 

It is reasonable to presume that all the IMF researchers involved in this kind of work must have been aware of such devastating implications of the upward revision of fiscal multipliers.  My colleague and good friend Giancarlo Gandolfo helped me to work out the proof of the proposition above linking the multiplier to the inverse of the Public Debt/GDP ratio, for which I am most grateful, but in all honesty he would be the first to point out that the proof does not involve the use of rocket science.  Cottarelli and Jaramillo (2012) who discuss the feedback loops between fiscal policy and growth, get remarkably close to that proposition, but use an obscure turn of phrase, and stop short of stating it in so many words, or mathematically:

“a deceleration of growth prompted by a fiscal consolidation could result in a rise in the government debt-to-GDP ratio. This is found to be the case if the initial stock of debt is large and the fiscal multiplier is high. The effect of fiscal tightening on debt (the numerator of the ratio) in percentage terms is smaller the higher the initial stock of debt to GDP. Meanwhile, the negative effect of fiscal tightening on GDP (the denominator of the ratio) is larger the higher the fiscal multiplier.”

The point is that although the participants in the debate "should not be reported as representing the views of the IMF", as stated in all IMF publications, naturally their writings are taken as a pointer to the way IMF views are evolving.  Therefore they must be anxious not to suggest that their upwards revision might result in perverse fiscal consolidations in all or near all advanced economies, and baulk at saying in so many words that fiscal consolidation backfires precisely in those highly indebted countries on which it is pressed most energetically. Thus Blanchard and Leigh (2013) are adamant:

“... our results should not be construed as arguing for any specific fiscal policy stance in any specific country. In particular, the results do not imply that fiscal consolidation is undesirable.”

And Cottarelli and Jaramillo (2012) make a case against abrupt, front-loaded and simultaneous fiscal consolidations (like Blanchard and Cottarelli had done separately in 2011 and 2012 respectively).  “It is imperative to lower Public Debt over time”, though:  “However, in the short-run, front-loaded fiscal adjustment is likely to hurt growth prospects, which would delay improvements in fiscal indicators, including deficits, debt, and financing costs. A measured, although not trivial, pace of adjustment, based on a clear medium-term plan, is therefore preferable, if market conditions allow it.” Nevertheless, they claim that fiscal consolidation and economic growth go “hand in hand”.

All researchers advocate structural reforms, precisely to offset the recognition that fiscal adjustment will slow down growth.  “Reforms in goods, services, and labor markets that improve economic efficiency will boost potential growth, in turn serving as important tools in the fiscal adjustment process” (Cottarelli and Jaramillo 2012). These cover a multitude of sins and virtues that have mixed and ambiguous effects, if any, and in any case only in a distant long-run.    The notion of a virtuous circle in which “pro-growth fiscal adjustment measures, other structural reforms, and lower debt boost growth and the latter facilitates fiscal adjustment” (ibidem) is pie in the sky, and a dangerous vision if it is used to justify perverse fiscal consolidation.

The proposition that fiscal consolidation harms development only when it is abrupt, front-loaded and internationally coordinated is a non-sequitur.

At this point two further considerations are in order.  First, we know – not least from Cottarelli and Jaramillo (2012, Appendix on Short-run Determinants of CDS Spreads in Advanced Economies) – that a country’s cost of borrowing tends to rise with the Debt/GDP ratio and with the fall in the growth rate, both phenomena being associated with “perverse” fiscal consolidation i.e. with the near totality of consolidations.  For “a deceleration of growth prompted by a fiscal consolidation could trigger nervousness in financial markets” and “...markets seem to have been focusing recently on short-term growth developments.”  “The possible increase in spreads when fiscal policy is tightened creates a problem for upholding a fiscal adjustment strategy, not only because higher financing costs increase the overall deficit, but also because of political economy reasons. If painful fiscal tightening is accompanied by early evidence of an improvement in credibility, the adjustment is more easily sustained, but if markets do not reward the effort, the resolve of the government to carry on the fiscal adjustment may be undermined.”  Therefore fiscal consolidation can and often does generate a vicious circle that makes Public Debt more and more unsustainable. 

Second, we know that in a prolonged depression productive capacity does not just stand idle but is actually destroyed: factories close down with no more than a fraction of their productive capital being re-deployed elsewhere, if at all, in other productive uses; human capital is also destroyed, as workers made redundant are dispersed, and their skills are lost or forgotten or made obsolete.  When actual output falls below potential output, at some point gross investment stops and net investment falls below zero as unused or obsolete capital is not replaced, thus reducing not only employment but the number of those “employable”, pulling down the growth path of potential output (Vianello 2005). “An insufficient demand protracted over time unavoidably generates a slowdown in the formation of new productive capacity and therefore of potential income” (ibidem). Discouraged workers will stop looking for work and the rate of participation will fall.  As Nicholas Kaldor (1983) had argued, “It is illegitimate to assume that there exists a long run equilibrium growth path, for a single country or even the world as a whole, determined by population growth, capital accumulation and the rate of technical progress, all taken exogenously [italics added].” (p. 95).

In such conditions, in the world as we know it, fiscal consolidation definitely can harm economic growth and development, even if it is not abrupt, front-loaded and internationally coordinated.  This is not to say that there are no limits to a country’s or even a group of countries’ ability to sustain a fiscal stimulus.  But fiscal consolidation has to be avoided absolutely as long as the GDP/Debt ratio is smaller than the fiscal multiplier – even if otherwise the country is growing less fast than the interest rate on its debt, for with perverse fiscal consolidation the country would continue to raise its Debt/GDP ratio even faster than with continued fiscal stimulus. 

This is true even if government expenditure consists of Keynes’ proverbial policy of hiring some workers digging holes and others filling them, that Tanzi (2012) would relegate “to the museum of old and wrong ideas” (p. 11).  Obviously the replacement of unproductive expenditure with productive investment has significant additional benefits over a continuation of unproductive investment such as digging and filling holes or building pyramids or cathedrals, but even the continuation of such unproductive investment is superior to fiscal consolidation.  

REFERENCES

Auerbach Alan, and Yuriy Gorodnichenko (2012a), “Fiscal Multipliers in Recession and Expansion,” in Alberto Alesina and Francesco Giavazzi, Fiscal Policy after the Financial Crisis, University of Chicago Press.

Auerbach Alan, and Yuriy Gorodnichenko (2012b), “Measuring the Output Responses to Fiscal Policy,” American Economic Journal – Economic Policy, Vol. 4, pp. 1–27. 

Auerbach Alan, and Yuriy Gorodnichenko (2012c), “Output Spillovers from Fiscal Policy,” NBER Working Paper No. 18578, Cambridge, Mass. 

Batini Nicoletta, Giovanni Callegari and Giovanni Melina (2012), “Successful Austerity in the United States, Europe and Japan”, IMF Working Paper 12/190, July, Washington.

Blanchard Olivier J. (2011), “Blanchard on 2011’s four hard truths”, 23 December,  http://www.voxeu.org/article/blanchard-2011-s-four-hard-truths 

Blanchard Olivier J. and Daniel Leigh (2012), “Box 1.1. Are We Underestimating Short-Term Fiscal Multipliers?” in International Monetary Fund (2012), World Economic Outlook - Coping with High Debt and Sluggish Growth, Chapter, “Global prospects and policies”, pp. 41-43., October, Washington.

Blanchard, Olivier J. and Daniel Leigh (2013), Growth Forecast Errors and Fiscal Multipliers, IMF Working Paper No. 13/1, January, http://www.imf.org/external/pubs/ft/wp/2013/wp1301.pdf 

Christiano Lawrence, Martin Eichenbaum, and Sergio Rebelo (2011), “When Is the Government Spending Multiplier Large?”, Journal of Political Economy, Vol. 119, pp. 78–121. 

Cottarelli Carlo (2012), “Fiscal Adjustment: Too Much of a Good Thing?”, Posted on January 29 by iMFdirect. 

Cottarelli Carlo and Laura Jaramillo (2012), “Walking Hand in Hand: Fiscal Policy and Growth in Advanced Economies”, IMF Working Paper WP12/137 http://www.imf.org/external/pubs/ft/wp/2012/wp12137.pdf

International Monetary Fund, (2010), World Economic Outlook: Recovery, Risk, and Rebalancing, October, Washington 

Kaldor Nicholas (1983), “The role of effective demand in the short run and the long run”, reprinted in Targetti Ferdinando and A. P. Thirlwall, Eds., (1989) Further essays on economic theory and policy – Collected economic essays, vol. 9, Duckworth, London. 

Tanzi Vito (2012), Realistic Recovery - Why Keynesian Solutions Will Not Work, http://www.politeia.co.uk/sites/default/files/files/Vito%20Tanzi%20Final.pdf London, Politeia.

Vianello Fernando (2005), “La Moneta Unica Europea”, mimeo, and in Economia & Lavoro (2013), XLVII-1, pp. 27-46. 

Euroarea: Premature, Diminished, Divergent

1. Expected Benefits and Costs of a Common Currency

The formation of a Common Currency Area is usually expected to generate at least seven gross benefits for its members.  

First, a reduction of transaction costs, such as the cumulative cost of converting one currency into another (and then another). 

Second, an increase in competition, given the greater transparency and comparability of prices once they are all expressed in a common currency.  

Third, a reduction of the rate of inflation, if the management of the common currency is subjected to greater discipline by an independent Central Bank targeting low inflation.  

Fourth, the elimination of exchange rate risk in transactions among member countries within the common currency area.  

Fifth, a lower interest rate associated with both lower inflation and the elimination of exchange rate risk.  

Sixth, in addition to all these factors expected to promote trade integration within the area, the promotion of greater foreign investment, given the investors’ ability to repatriate profits freely in the same currency in which they are earned.

Finally, there are the benefits expected of greater financial integration, which would provide among other things a form of implicit insurance against asymmetric shocks.   

Conversely, there are also at least three gross drawbacks to be expected by the members of a Common Currency Area.  First, the loss of national monetary policy, potentially serious in case of asymmetric shocks.  Second, the loss of the national exchange rate as a policy instrument, especially the loss of currency devaluation as a means to enhance national trade competitiveness.  Third, the fiscal discipline involved for national governments by membership of the Area. 

On balance, there is an expectation of positive net benefits from the establishment of a Common Currency.

2. Actual Benefits and Costs of the Euroarea

The creation of the Euroarea has resulted in a mixture of actual benefits and drawbacks of different sizes, trends and net balance over time.  Savings in transaction costs in currency conversion clearly have been grossly exaggerated, since those costs are incurred only for a possible currency mismatch between monetary revenues and expenditures.  Prices can be easily expressed in any currency chosen as numéraire, so that greater transparency is a delusion.  Inflation has been tamed successfully by the European Central Bank and brought down below the best earlier performance of the Bundesbank, but by 2013 labour unemployment has reached record levels in the Euroarea.  Interest rates have fallen with the introduction of the euro and gradually have converged to roughly a uniform low level maintained for seven and half years until 2010 when the spread between national borrowing rates and the lowest rate paid by a member country (Germany on its long term Bunds) has widened spectacularly, together with the cost of insuring against country default with CDS (Credit Default Swaps).  Banking integration within the Euroarea turned into a mechanism of contagion.  Asymmetric shocks – a serious concern when the Euro was established – have not been a major problem, but the inability to implement an external devaluation has brought about alternative and costly measures of internal devaluation i.e. deflation of wages and prices.  Fiscal discipline in the form of concerted austerity, within the whole Union and not only in the Euroarea, has depressed GDP and employment in the area as a whole and especially in the Southern members states, to a greater extent than the resulting reduction of debt thus raising debt/GDP ratios and widening their divergence (on this point see below). 

Since the Greek crisis of 2010 and successive crises in other member countries the possibility has been seriously and widely discussed of the Euro-area splitting into its national components with the restoration of national currencies, or at least splitting into groups such as a Nordic and Southern group with a currency respectively stronger and weaker than the Euro as it is today.  (See Cambridge Journal of Economics, Special Issue on Prospects for the Eurozone, Volume 37 Issue 3 May 2013, downloadable free of charge). While initial calls for Euroarea break-up were initially expressed by rightwing circles, recently they were joined by leftwing circles (for a critique see Andrew Watt, Why Left-wing Advocates Of An End To The Single Currency Are Wrong, 10-07-2013).

3. The Euro-Area: three failures

The Euroarea has suffered greatly from two major design failures, which are the original sins of the Common Currency, and from the member states’ increasing divergence from a common economic pattern instead of converging.

The first failure consists in the Euro’s premature birth.  The Common Currency was supposed to be the very last stage of economic integration, “crowning” all the other prior stages: after political integration, after fiscal integration including a European budget on a large enough scale to allow for a European fiscal policy, after defense and foreign policy integration.  Instead of which when the euro was set up, and still today, there is no European government, but only a movable collection of national Ministers that mostly legislate in place of a Parliament which remains largely a debating Club, next to a powerful European Commission of unelected Commissioners and powerful civil servants with executive powers, while policy-making remains at the inter-governmental level.  The European budget was set at a derisory 1%-2% of European GDP (instead of around 20% as the US Federal Budget) and always balanced ex-post (thus without the possibility of a primary surplus, let alone one large enough to service bonds issued by the EU, which in any case the EU has no need or reason to issue because it is not allowed to run a deficit).  In both defense and foreign policy only the first embryonic, bureaucratic steps towards European integration were taken. 

The approach followed in Euro creation was the exact opposite of what it should have been, technically, not to mention democratically: the Common Currency was established out of sequence deliberately, precisely so as to create, through a kind of “controlled dysfunction”, the pressures and tensions that it was hoped would push forward “la finalité politique” and all the other integration stages that are still missing.  This was a risky strategy that worked only temporarily and should have been rapidly followed, but was not, by filling in the missing stages in order to succeed.

The second failure of the Common Currency design was the creation of a diminished European Central Bank.  The ECB was made independent – following the then fashionable theories of rational expectations and the alleged lack of a trade-off between inflation and unemployment associated with them – like the US Federal Reserve, the Bank of England and the Central Bank of Japan.  However – unlike these sister institutions but on the Bundesbank template – the ECB was also totally disconnected from fiscal policy.  The ECB was supposed to target inflation at a rate below 2%, though close to it; to disregard employment concerns unless and until the inflation target was met, but above all was prevented from buying government bonds whether they were issued by Europe (which the EU was not supposed to issue, other than through the European Investment Bank) or by member states.  

And when it was set up the ECB did not have any of the other traditional functions of a Central Bank: bank supervision, bank re-capitalisation and resolution in case of insolvency, deposit insurance – all functions that were retained by National Central Banks, and still are except for some devolution in progress of bank supervision to the ECB. 

Inability to fund public expenditure, to supervise, re-capitalise and resolve banks and insure deposits made the ECB only half of a Central Bank, or possibly even less than half.  There have been initiatives to establish some version of a “banking union”: strictly speaking there is no such a thing, and one would look in vain for such an institution in the textbooks on International Integration. There are only make-shift provisions to somehow alleviate the lack of those traditional Central Bank functions on the part of the ECB.

The third failure of the Euroarea is, after almost 10 wasted years of successful operation with low and uniform interest rates, the EMU member states’ failure to converge to the statutory parameters fixed by the Maastricht Treaty for EMU accession and by the euphemistically labelled Growth and Stability Pact for all EU members.  This is true both of monetary convergence – of long term interest rate on 10 year government bonds, and of the rate of inflation – and of fiscal convergence maintaining the budget deficit and public debt respectively below 3% and 60% of GDP, in addition to two-year stability of the exchange rate between the national currency and the Euro.  EMU countries also failed to converge to other, real parameters that had never been targeted but – in view of the Euroarea premature and incomplete design – should have been targeted, like labour unemployment, unit labour costs (wage rates possibly remaining uneven but proportional to labour productivity), the trade balance, the share of bad loans in bank portfolios.  Instead of converging, the relevant parameters of Euroarea members have become increasingly divergent during the recent crisis.

A premature birth would have been alright if the European Central Bank had been designed on the Bank of England or the Fed or the Bank of Japan template instead of the Bundesbank.  Neither a premature birth nor a diminished Central Bank would have mattered if member states had converged to common monetary, fiscal and real parameters.  But the combination of these three failures, including increasing divergence, is potentially lethal.  The Euroarea as it is today might be able to struggle on still for an unspecified time, but ultimately is undoubtedly doomed.

4.  Recent Developments

In 2010 the interest rate spread widened between the Southern members of EMU and the most “virtuous” Nordic members of EMU, notably Germany – indeed too virtuous in view of its excessive success in promoting net exports currently of the order of €210 bn or 6% of its GDP, without any mechanism or policy attempt in Germany or in Europe to eliminate or even reduce that imbalance that has been very damaging to all other EMU and EU members and ultimately to Germany itself.

 

The history of the following three years to date is that of partial, slow and ineffective improvements, and of the courageous and imaginative unconventional measures introduced by the ECB President Mario Draghi to make the ECB function almost like a genuine Central Bank against stern German opposition. 

In 2010-2013 two temporary EU funding programmes provided instant access to financial assistance to Euroarea member states in financial difficulties: the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM).  In September 2012 they were replaced by the permanent ESM (European Stabilisation Mechanism, while the EFSF and EFSM will continue to manage transfers and programme monitoring for the earlier bailout loans to Ireland, Portugal and Greece).  However the ESM was somewhat under-funded (€500bn) to be able to cope with a large-scale crisis that might include at least one of the larger member states, and subject to the adoption of recessionary austerity and painful reform programmes under Troika supervision (EC, ECB, IMF).

 

Two new unconventional instruments were introduced by the ECB under Mario Draghi’s leadership, in order to restore monetary transmission mechanisms: Long Term Re-financing Operations (LTROs), through which the ECB provided injections of low interest rate funding to euro zone banks against wide-ranging collateral, and Outright Monetary Transactions (OMT) through which the ECB could purchase government bonds of troubled countries in the secondary markets – a master stroke whose sheer announcement has had a stabilizing impact on financial markets without the ECB spending a single cent yet.  Recently interest rate cuts were made, down to a record low of 0.5% and announced to be persistent and possibly ready to fall further down to reach the negative range. 

These developments have been persistently opposed especially by German representatives within the ECB Board and challenged as improper or outright illegal (including by bringing complaints to the German Constitutional Court in Karlsruhe).  Germany also has been opposing vigorously any suggestion of even partial mutualisation of debt within the Eurozone through the issue of Eurobonds subject to collective and several responsibility of member states – an understandable objection as Germany would risk to end up with sole responsibility as the most creditworthy party (though similar operations both in the early stages of the United States Federation and in 1862 in United Italy are said to have been advantageous to all parties involved). 

Of course the ECB has access to large-scale resources which are not recorded in its balance sheet, namely the present value of its seigniorage on the Euro (the profits obtained from monetary base issues, the interest obtained from the investment of past issues, the anticipated inflation tax i.e. the loss in real value of the stock of monetary base caused by expected inflation, as well as the unanticipated inflation tax).

The present value of ECB seigniorage was estimated by Willem Buiter to have a present value of the order of €3.3 trillion (in “The Debt of Nations Revisited: The Central Bank as a quasi-fiscal player: theory and applications”,  2011).  Its use to retire a sizeable part of Euroarea members’ debt in the same proportions in which they hold ECB shares would solve the Euro crisis without transforming the Eurozone into a “Transfer Union”, as it would not involve any redistribution across member states.  Potentially inflationary consequences of such an operation could be neutralized by reducing the size of the ECB balance sheet (selling assets and reducing loans), sterilizing monetary liabilities, raising obligatory reserves and raising the remuneration of excess reserves in order to induce banks to keep them inactive.  However this kind of operation would go against the grain of German and other Nordic members’ monetary conservatism and is unlikely to be undertaken.   

Hopes have been expressed of a softening of German opposition to the creative transformation of the ECB, or at least of its staunch support for austerity, after the German elections of September 2013.  But there are always frequent elections in every country at the national, regional and/or at the European level (next in 2014), and German opposition does not encourage the notion of a change of mind even in unlikely case of political alternation in power.

5. What now?

The missing integration stages and the missing institutions could be filled in, and convergence promoted more seriously and vigorously than in the past.  It is not clear whether all this could be done far enough and fast enough to resolve the current crisis, but this is unknown and is not a good reason not to try.  Or the Euroarea – as it is being suggested with increasing frequency – should and will split into its member countries, or possibly into a Nordic and a Southern currency areas with different common currencies (it has even been suggested that the two currencies might still be managed by the ECB with different targets and policies). 

By exiting the Euroarea and restoring a national currency, a country would be able to conduct its own monetary policy, presumably reflating its economy and choosing its own desired trade-off between inflation and unemployment. It could, if it wished, choose a Central Bank template still independent but also able to fund government expenditure (like the Bank of England), except that this might not be much use seeing that even by exiting EMU a country, as long as it still remained in the EU would have to adopt austerity policies, imposed on all EU members by the so-called Growth and Stability Pact. 

The exiting country could restore international competitiveness via nominal devaluation of its currency, instead of having to do it via painful and unpopular internal deflationary policies of wage and prices. And it could default – unilaterally or by agreement with its creditors – and bail-in creditors thus reducing its debt, as it could if even it remained a member but without having to agree with the Troika (EC, ECB, IMF) the terms of the bail-in and without ECB and EC (but possibly still with IMF) assistance.  Of course, EMU membership remaining one of the requirements of EU membership, a country leaving the Euroarea would sooner or later, if not at once, have to leave the EU – a non negligible cost of Euro exit. 

Exit from the Euro might be forced onto a country by a bank run, in conditions in which the ECB could not guarantee emergency liquidity assistance: such situation was approached in Cyprus in 2013 when the government initially failed to agree on the terms imposed by the Troika for bailing-in its banks.  At that point the only way to maintain liquidity would be the introduction – by the National Bank or the Treasury – of a national currency, say a National Euro, initially issued at par with the Euro.  Subsequently the new national currency would inflate and devalue, for it would have to float so that the euro does not disappear from circulation due to Gresham’s law.  Indeed the new national currency would probably inflate and devalue at shockingly high rates.  Interest rates in the new currency as a result would increase fast relatively to those of the euro.  Euro exit by several small or just one large country would probably trigger off a run on the banks of other weak Euroarea members and unleash an unnecessary domino effect.

If and when the new national currency regained parity between its floating rate and the rate at which it had been originally issued against the euro, the operation could be reversed: the country could re-join the Euroarea and the National Euro converted back into Euros.  Until then Euro cash would become foreign exchange in the hands of households and companies, current accounts and all debt and credits would be converted into the new currency at par, which by itself would reduce the size of all debt.  International debt technically would remain nominally denominated in Euro or other foreign currencies (at least for the greater part of debt incurred under English Law), but creditors would have to resign themselves to debtors’ default and to de facto bail-in.  Devaluation would improve competitiveness if it was real (nominal devaluation not being offset by higher inflation) and sufficiently large. 

Frequently there have been suggestions that the new national currency should not replace the Euro but circulate in parallel with it.  Unfortunately there are no miracles in economics, a parallel currency would be a messy and doubtful solution.  Considering that internal devaluation and default are options even within the Euro, and that fiscal discipline remains one of the obligations of EU membership even for a country exiting the Euroarea the only advantage of leaving the Euro would be greater freedom to default, at the cost of losing some European support by the EU and the ECB, but still subject to both assistance and conditionality by the IMF.

In conclusion there would not be much of a net gain from Euroarea exit, especially considering that exit with default would bar a country from access to international markets for longer (up to twenty years or so) than orderly default and bail-in as in the cases of Greece, Ireland or Cyprus.

As for Germany (and possibly other Nordic countries) leaving the Euro, as recently suggested by George Soros, their exit probably grossly under-estimates German losses from revaluation of the Nordic vis-à-vis a hypothetical Southern Euro.

6.  “If I wanted to go to Rome I would not start from here”

Clearly if one had wanted to construct a Common Currency Area one should have not proceeded in the way that was followed by the EMU, and certainly would not wish to start from the current state of affairs in the Euroarea.  But starting from here perhaps the best course is to press on as far and as fast as the limited consensus among members will take the weaker and more vulnerable members, towards filling in the missing elements: building some kind of Banking Union; supporting ECB progress towards a de facto proper Central Bank; sustaining political integration and fiscal integration, raising the size of the European Budget; trying to re-launch European investment initiatives and funding European instead of national debt.  

To these purposes it would be expedient to threaten an exit vigorously and increasingly rather than actually leaving the Euroarea.  At the same time a country could, still remaining in the Euroarea, and if democratic institutions were sufficiently robust, mimic with internal devaluation the effects of an external devaluation that leaving the Euroarea would allow – but only if this is regarded as essential to re-launch growth.

Austerity Can Kill You

In 1962 the RCP (Royal College of Physicians) published a Report on Smoking and health  in the UK. Using research by Sir Richard Doll and Sir Austin Bradford Hill, the Report established conclusively the link between smoking - including passive smoking - and lung cancer, other lung diseases, heart disease and gastrointestinal illnesses. It caused a sensation, and received an ambivalent, often hostile response from the media, governments and society. In 1962 tobacco "smoking was omnipresent, accepted, established." "[In the UK] around 70% of men and 40% of women smoked". It was "a world suffocated by the swirling clouds of tobacco" - "in pubs, cinemas, trains, buses, on the streets, and even in hospitals and schools." [from the RCP-Royal College of Physicians report on Fifty years since Smoking and Health – progress, lessons and priorities for a smoke-free UK, 2012]. 

Gradually government action reduced this phenomenon.  By 2012 "... smoking is no longer the norm. Our schools, hospitals, pubs, cinemas and public transport are subject to smoke-free legislation. [In the UK] Only 21% of the population smokes. Government, media and society have largely accepted the need to protect people, particularly children, from much of the harm associated with tobacco smoke." Still, in the UK it took fifty years to achieve such a large reduction in smoking incidence. Smokers are still 21% of the population too many, they represent glaring evidence of either irrationality or addiction or both, and the persistence of vested interests by tobacco and cigarettes producers.

Austerity - aiming at a balanced government budget, reducing expenditure and raising taxation even in the middle of an economic recession - also has been the norm for a very long time, and still is enshrined in the statutory policies of EU and EMU, of IMF and ECB. Yet we have known at least since 1936 (with the publication of Keynes' General Theory), indeed since 1933-35 (the dates of Michal Kalecki's anticipations of Keynesian propositions, see Robinson 1976 and Nuti 2004) that austerity can cause unnecessary, involuntary unemployment of labour and irreversible losses of income and consumption.

In our time and age austerity is more incomprehensible than smoking, were it not for the irrational fear of inflation in the middle of a recession, the generalised addiction to hyper-liberal ideologies and the vested interests of those who think they benefit from labour unemployment keeping workers "in their place". What is worse, austerity today is much more widespread than smoking, it is on the rise and is officially supported by our national and international authorities more than it ever was, while at least smoking is steadily declining not least because of progressive health policies worldwide.

Feasible full employment

In 1943 Michael Kalecki could write that “A solid majority of economists is now of the opinion that, even in a capitalist system, full employment may be secured by a government spending programme, provided there is in existence adequate plant to employ all existing labour power, and provided adequate supplies of necessary foreign raw-materials may be obtained in exchange for exports”. As long, of course, as such government spending programme is “financed by borrowing and not by taxation”. Kalecki even dealt with the case of highly indebted countries, which also could afford and attract loans to finance government expenditure as long as interest was paid out of a capital levy.

Opposition to such a policy of full (meaning high and stable) employment would be political: "(i) opposition in principle to government spending based on a budget deficit; (ii) opposition to this spending being directed either towards public investment – which may foreshadow the intrusion of the state into the new spheres of economic activity – or towards subsidizing mass consumption; iii) opposition to maintaining full employment and not merely preventing deep and prolongued slumps”. Such objections subside in the slump, and are revived in the boom, thus generating what Kalecki called a "political cycle" and a generally lower average degree of employment over such cycle than otherwise feasible. 

But the feasibility of Kaleckian-Keynesian full employment policies soon ceased to enjoy the support of a "solid majority of economists". The effectiveness of expansionary fiscal policy was challenged on an escalation of arguments.

From deficit spending to expansionary fiscal consolidation

First, it was argued that government expenditure would “crowd out” private investment. This idea neglects the possibility of private investment on the contrary “crowding in” additional expenditure due to the activation of its accelerator effect of higher primary demand. On the contrary, Dennis Robertson (in a talk given at Princeton in 1953) argued that at least some of the additional savings out of the income generated by government spending would not represent a leakage but would be channeled into additional investment, and called this “the Kalecki effect”.

Second, Ricardian equivalence was invoked, tentatively put forward by David Ricardo in the early 19th century and re-discovered by Robert J. Barro in 1974. When government expenditure is raised, funded by borrowing, economic agents discount the future payments of higher taxes that they anticipate having to pay to service the higher debt. The effect is the same as it would be if expenditure was funded directly by an immediate higher tax: lower private consumption offsetting higher government expenditure. (The reader is invited to perform a mental experiment: is this how he/she responds to a fiscal stimulus by the government? I certainly don't).

Third, in the early ‘seventies the theory of so-called rational expectations was introduced by Robert Lucas and others, which was a tendentious misnomer. They should have been called expectations successful by definition. The efficient utilization of all information available, by all economic agents, makes markets efficient. Nobody is ever surprised. Multipliers could then be lower than unity.

Fourth, in the 1990s and 2000s a series of empirical studies propounded the idea of “Expansionary Fiscal Contraction”. They argued that closing the budget deficit via higher taxes and/or lower expenditure can be and by and large is expansionary: see Giavazzi and Pagano (1990, 1996); Alesina and Perotti (1997); Alesina and Ardagna (2010). Blanchard (1990, then Professor at MIT, before joining the IMF as Chief Economist in 2008) explained how this was due to the promotion of private sector-led growth, for the reasons already mentioned above: Ricardian equivalence, increasing confidence, a favourable impact on expectations, declining borrowing costs, a weaker currency. This would hold also for "extreme" fiscal contraction or consolidation.

Growth in a Time of Debt

But the culmination of the expansionary fiscal consolidation thesis, supported by the so-called "austerians"' - "advocates of fiscal austerity, of immediate sharp cuts in government spending" (Krugman's definition) - is a paper by Harvard economists Carmen Reinhart and Kenneth Rogoff, "Growth in a Time of Debt" (2010). On the basis of a new dataset of forty-four countries spanning about two hundred years, incorporating “over 3,700 annual observations covering a wide range of political systems, institutions, exchange rate arrangements, and historic circumstances”, Reinhart and Rogoff find that “the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.” 

The notion that government debt exceeding 90 percent of GDP has a significant negative effect on economic growth became a decisive supportive argument for austerity by national and international leaders, from ex-vice-presidential candidate Paul Ryan, chairman of the USA Congress budget committee, to EC Commissioner Olli Rehn, and authoritative commentators. Thus Keynes's proposition that “the boom, not the slump, is the right time for austerity” was falsified, austerity becoming a good policy for all seasons in highly indebted countries.

The tide is turning

The proposition of "Expansionary Fiscal Consolidation" was immediately subjected to many criticisms and was gradually discredited both on theoretical and on empirical grounds.

Already in November 2008 the IMF Managing Director Dominique Strauss-Kahn took the initiative for a sizeable global fiscal stimulus of the order of 2% of Global GDP. In an interview with IMF Survey Online on 29 December 2008 Olivier Blanchard – by then IMF Chief Economist, and Carlo Cottarelli, Chief of the IMF Fiscal Affairs Department, called for bank recapitalization (time consuming) and monetary expansion (ineffective at low interest rates) and made a strong case for fiscal stimulus: "In normal times, the Fund would indeed be recommending to many countries that they reduce their budget deficit and their public debt. But these are not normal times, and the balance of risks today is very different"… "If no fiscal stimulus is implemented, then demand may continue to fall. And with it, we may see some of the vicious cycles we have seen in the past: deflation and liquidity traps, expectations becoming more and more pessimistic and, as a result, a deeper and deeper recession. If, instead, a fiscal stimulus is implemented but proves unnecessary, the risk is that the economy recovers too fast. Surely, this risk is easier to control than the risk of an ever deepening recession." The IMF raised its lending, increased its own resources and relaxed somewhat its conditionality, but its commitment was intermittent and short lived. The ECB, under the leadership of Jean-Claude Trichet, soon was advocating an early exit strategy from both monetary expansion and fiscal stimulus.

In October 2010, Chapter 3 of the IMF World Economic Outlook examined “the effects of fiscal consolidation — tax hikes and government spending cuts—on economic activity.” It found that fiscal consolidation typically reduces output and raises unemployment in the short term, especially if it occurs simultaneously across many countries, and if monetary policy is not in a position to offset them. Only in the longer term, can interest rate cuts, a fall in the value of the currency, and a rise in net exports usually “soften” but do not offset the contractionary impact.

Baker (2010) criticises Alesina and others (1995, 2006) for their use of cyclically adjusted deficits, while policy driven deficit adjustments behave in a keynesian fashion. He also criticises Broadbent and Daly (2010) on the ground that known cases of expansionary consolidation occurred for very narrow output gaps relatively to the large ones that occur in the current crisis.

The September 2011 IMF Fiscal Monitor warned that “too rapid consolidation during 2012 could exacerbate downside risks”: “Further tightening during a downturn could exacerbate rather than alleviate market tensions through its negative impact on growth”.

In 2012 Carlo Cottarelli stressed the “schizophrenic” attitude of investors with regard to fiscal consolidation manoeuvres: their initial enthusiasm is followed by the fear of consequent recession, so that governments are “damned if they do, damned if they don’t”.

The IMF World Economic Outlook (October 2012) contains a large Box by its Chief Economist Olivier Blanchard and Daniel Leigh arguing that fiscal multipliers have been under-estimated by IMF forecasts and policy documents, by the OECD and the European Commission. Recent IMF research suggests that fiscal multipliers are in the range 0.9 to 1.7, rather than the customary assumption of their being around 0.5. In other words, the cost of fiscal consolidation has been grossly under-estimated. In January 2013 Blanchard and Leigh presented a longer paper expanding their argument at the American Economic Association Annual Conference. However, according to the auhors “More research is needed.”

But more research was already available to the IMF: Guajardo, Leigh and Pescatori (2011) investigated "the short-term effects of fiscal consolidation on economic activity in OECD economies." "We examine the historical record, including Budget Speeches and IMF documents, to identify changes in fiscal policy motivated by a desire to reduce the budget deficit and not by responding to prospective economic conditions. Using this new dataset, our estimates suggest fiscal consolidation has contractionary effects on private domestic demand and GDP. By contrast, estimates based on conventional measures of the fiscal policy stance used in the literature support the expansionary fiscal contractions hypothesis but appear to be biased toward overstating expansionary effects.”

And Batini-Callegari-Melina (2012)
-  discredit the need for cutting public/social expenditure, for especially in a downturn expenditure multipliers can be up to ten times larger than tax multipliers;
- find absolute values for multipliers of the order of 2.5 instead of 0.9-1.7 as in the IMF World Economic Outlook (2012);
- find aggressive consolidation much more expensive than gradual in terms of GDP.

In May 2013 Jeffrey Frankel criticized various papers by Alesina and other co-authors (Giavazzi, Ardagna and Favero), all claiming that fiscal consolidation is not contractionary in a recession. Frankel’s objections are based on a recent paper by Alesina's original coauthor, Perotti, criticizing the dating methodology used, and pointing out that some of the fiscal consolidations used by Alesina et al. were announced by governments but never implemented. Thus Frankel concludes that Alesina "has not been receiving his fair share of abuse” (Eurointelligence.com, 22/5/2013).

At the same time Alesina and Giavazzi softened very considerably their original position. In May 2013 they actually recommended the Italian government to overstep the 3% deficit threshold for two years – for “that three per cent should not be a taboo” – offering the EC in exchange  immediate tax reductions on labour incomes and planned gradual and permanent expenditure cuts in the following three years. The European Commission would not close the excess deficit procedure for Italy at end-May but should be willing to approve such plan and verify its implementation. At the same time, credit to households and enterprises should resume through bank re-capitalisation conditionally funded by the EMS.

The non-existent 90% threshold

The Reinhert-Rogoff notion of a critical 90% threshold of the debt/GDP ratio was immediately criticized by Irons and Bivens (2010) who argued that causation run backwards, in that slower growth leads to higher debt-to-GDP ratios rather than the other way round. Moreover “there is no compelling reason to believe … that gross debt of about 90% will necessarily lead to slower economic growth… In fact, the greatest threat to economic growth is policy inaction fueled by deficit fears.”

The final blow to the Reinhart-Rogoff 90% debt/GDP dogma came from Herndon, Ash and Pollin (2013), who replicated the analysis by Reinhart and Rogoff 2010 using the original data. Apart from a coding error, which made only a small contribution to their conclusions, Reinhart-Rogoff selectively excluded available data for several Allied nations—Canada, New Zealand, and Australia—that emerged from World War II with high debt but nonetheless exhibited solid growth. And summary statistics were all weighted equally regardless of the duration of high debt and growth performance. Herndon et al. (2013) conclude that “… when properly calculated, the average real GDP growth rate for countries carrying a public-debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not 0.1 percent as published in Reinhart and Rogoff”. It turns out that “average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when debt/GDP ratios are lower.”

Reinhart and Rogoff (2013) admitted some of their errors and omissions but argued that these do not alter their ultimate austerity-justifying conclusion: excessive debt depresses growth. But two subsequent studies have claimed that, on the contrary, slow growth appears to cause higher debt (as Irons and Bivens 2010 had already argued). Dube (2013) finds that growth tends to be slower in the five years before countries have high debt levels. In the five years after they have high debt levels, there is no noticeable difference in growth at all, certainly not at the 90 percent debt-to-GDP level regarded by Reinhart and Rogoff as the threshold of non-sustainability. Kimball and Wang (2013) present similar findings. This point is accepted by Reinhart-Rogoff (2013): "The frontier question for research is the issue of causality."

But suicidal policies persist

Such an amazing, cumulative and final discrediting of the alleged expansionary (severe at that) fiscal contraction approach, and the associated 90% threshold to debt sustainability, does not appear to have had much impact on actual policies, especially on German-led European policies, with EU and especially EMU countries tied to the "suicide pact" (Joseph Stiglitz) of so-called Growth and Stability.

The latest EU Fiscal Compact or TSCG – Treaty on Stability, Coordination and Governance – demanded a balanced budget provision to be inserted in member states’ national constitutions, subject to a maximum structural deficit of 0.5% of GDP. There are penalties and automatic adjustments in case of inobservance, subject to the verification and rulings of the European Court of Justice. Financial assistance programmes under the ESM – the European Stability Mechanism that come into operation in March 2012 – from March 2013 are conditional on prior TSGC ratification.

From 2015 countries exceeding the statutory debt/GDP ceiling of 60%, required by both the Maastricht Treaty and the Stability and Growth Pact, are expected to reduce the excess debt by 1/20 of the current gap every year until the ceiling is reached – which for a country like Italy at over 130% involves a budgetary surplus of over 3.5% a year for 20 years.

The IMF (2013) Report criticized the Troika’s [EC, ECB, IMF] handling of the Greek crisis over the last four years, but concluded that all was for the best and their policies would not be any different today in the same circumstances. In July 2013 a conference of German economists advocated that a debt/GDP ratio of 90% - Reinhart and Rogoff’s fated but dubious threshold – should trigger off automatic debt re-structuring and bail-in.

Austerity is like compulsory smoking

In conclusion, the Keynesian-Kaleckian view of capitalist dynamics is alive and well. The IMF itself has been reviving it and providing theoretical and empirical backing for it, by stressing the high cost of fiscal consolidation, but at the same time continuing to officially recommend and impose such fiscal consolidation. While providing the strongest case for a fiscal stimulus, IMF research is being used even by their more enlightened officials to recommend gradual rather than abrupt fiscal consolidation, instead of the fiscal stimulus that would be appropriately needed. Obstacles to full employment policies are still of a political nature today (resistance to a capital tax to service exceptionally high sovereign debt, in addition to the drive to maintain workers’ discipline through unemployment). The time for a Kaleckian (and Keynesian) over-due revival is now, but until it takes place we are all condemned to suffer from the impoverishment and the unemployment caused by the deepest, man-made, economic crisis in human history.

                            REFERENCES 

Alesina, A. and R. Perotti (1995). “Fiscal Expansion and Adjustments in OECD Economies”, Economic Policy, 207-247.

Alesina, A., S. Ardagna, and F. Trebbi (2006), “Who Adjusts and When? The Political Economy of Reform”, IMF Staff Papers, V. 53 Special Issue, Washington.

Alesina Alberto and Francesco Giavazzi, (2013), “Crescita, una proposta alternativa: Quel tre per cento non sia un tabù”, Corriere della Sera, 17 May.

Baker Dean (2010), “The Myth of Expansionary Fiscal Austerity”, CEPR, October.

Barro Robert J. (1974), “Are government bonds net wealth?”, Journal of Political Economy 82(6), pp. 1095-1117.

Batini Nicoletta, Giovanni Callegari and Giovanni Melina (2012), “Successful Austerity in the United States, Europe and Japan”, IMF Working Paper 12/190, July, Washington.
Blanchard Olivier J. (1990), “Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries: A Comment”, NBER Macroeconomics Annual Vol. 5, (1990), pp. 111-116, MIT Press, Cambridge, Mass.
Broadbent, B. and K. Daly (2010), “Limiting the Fall-Out from Fiscal Adjustments”, Goldman Sachs Global Economics Paper 195.

Cottarelli Carlo (2012), “Fiscal Adjustment: Too Much of a Good Thing?”, Posted on January 29 by iMFdirect.

Dube Arindrajit (2013), “A Note on Debt, Growth and Causality”, Draft forthcoming, May 30.

Giavazzi Francesco and Marco Pagano (1990), “Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries”, NBER Macroeconomics Annual Vol. 5, (1990), MIT Press. Cambridge Mass.

Giavazzi Francesco and Marco Pagano (1996) "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," NBER Working Papers 5332, National Bureau of Economic Research, Inc.

Guajardo Jaime, Daniel Leigh and Andrea Pescatori (2011), "Expansionary Austerity: New International Evidence", IMF WP/11/158, Washington. don Thomas, Michael Ash and Robert Pollin (2013), “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Political Economy Research Institute, Working paper n. 322, April 15, Amherst.

Irons John and Josh Bivens (2010), “Government Debt and Economic Growth: Overreaching Claims of Debt “Threshold” Suffer from Theoretical and Empirical Flaws”, Economic Policy Institute, 26 July, Briefing Paper #271.

International Monetary Fund (2010), “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation.” World Economic Outlook, Chapter 3, Washington.

International Monetary Fund (2013), “Greece: Ex Post Evaluation of Exceptional Access Under the 2010 Stand-By Arrangement,” June, Washington.

Kalecki Michal, (1933) Proba teorii koniunktury [An Essay on the Theory of Business Cycle], Instytut Koniunktury I Cen, Warsaw. As “Outline of a theory of the of Business Cycle”, in Kalecki, 1971.

Kalecki Michal (1934), “On foreign trade and ‘Domestic Exports’”, translated from Polish in Kalecki (1971).

Kalecki Michal (1935), “A macrodynamic theory of business cycles”, Econometrica 3, July, pp. 327-44.

Kalecki Michal (1943), “Political aspects of full employment”, The Political Quarterly, p. 332-331.

Kalecki Michal (1971), Selected essays on the dynamics of the capitalist economy 1933-1970, CUP, Cambridge.

Keynes J. Maynard (1936), The General Theory of Employment, Interest and Money, London, Macmillan.
Kimball Miles and Yichuan Wang (2013), “After crunching Reinhart and Rogoff’s data, we’ve concluded that high debt does not slow growth”, QUARTZ, 29 May.

Olivier Blanchard and Daniel Leigh, “Growth Forecast Errors and Fiscal Multipliers,” IMF Working Paper, January 2013.

Lucas Robert (1976), "Econometric policy evaluation: A critique", Carnegie-Rochester Conference Series on Public Policy 1 (1), pp. 19–46.

Nuti Domenico M. (2004), “Kalecki and Keynes Re-visited”, in Zdzislaw L. Sadowski and Adam Szeworski (Eds), Kalecki’s Economics Today, Routledge, London and New York.

Reinhart, Carmen M. and Kenneth S. Rogoff (2010), "Growth in a Time of Debt", NBER Working Paper No. 15639, January.

Reinhart, Carmen M. and Kenneth S. Rogoff (2013), “Responding to Our Critics”, The New York Times, 25 April.

Robinson Joan V. (1976), “Michael Kalecki: a neglected prophet”, New York Review of Books, 23, 4 March, pp. 28-30.

A CORRECTION:

In my answer to Branko (see Comments to this post) I wrote:

"If the size of the fiscal multiplier (which is the weighted average of the multipliers applicable to various expenditure cuts and tax rises involved) is greater than the current debt/GDP ratio, as the latest IMF researchers suggest, then fiscal consolidation raises such a ratio."

I should have written:

"If the size of the fiscal multiplier (which is the weighted average of the multipliers applicable to various expenditure cuts and tax rises involved) is greater than the inverse of the current debt/GDP ratio, as the latest IMF researchers suggest, then fiscal consolidation raises such a ratio."