UK's prime minister Cameron has delivered a tight budget with tax increases. Japan is moving to tighten its budgets and increase taxes on the wealthy. The US is still in the spending mode. with the year 2 of the $847 billion stimulus package So now we have an interesting test of whether fiscal austerity or Keynesian spending will be the driver for economic growth.
The answer should be easy. Follow the Keynesian prescription especially when there is an output gap. But the reality is never so simple. The tighter budgets in some European countries is a reaction to the sovereign debt problems in the EU. The basis for the tighter budgets is that capital will move out of risky sovereigns driving p interest rates which will reduce investments. Clerly, at the extrems this will be true, but this seems very similar to the tightening proposed during the Great Depression. It can have unintended effects. I would argue that the market looks for counter-cyclical spending during a recession This is helpful because there is less private investment. The market doe snot like structural deficits which have been building across Europe and Japan.
Some have argued that the key is to cut spending without raising taxes. Goldman Sachs economist have found that a 1% cut in spending will led to a .6% increase in growth Raising taxes to GDP by 1% will cut growth by .9%. The multiplier effects are not what is normally expected. Paul Krugman, on the other hand, argues that any cut in stimulus would be "utter folly". The "folly seems to be the new trend in Europe.
The answer should be easy. Follow the Keynesian prescription especially when there is an output gap. But the reality is never so simple. The tighter budgets in some European countries is a reaction to the sovereign debt problems in the EU. The basis for the tighter budgets is that capital will move out of risky sovereigns driving p interest rates which will reduce investments. Clerly, at the extrems this will be true, but this seems very similar to the tightening proposed during the Great Depression. It can have unintended effects. I would argue that the market looks for counter-cyclical spending during a recession This is helpful because there is less private investment. The market doe snot like structural deficits which have been building across Europe and Japan.
Some have argued that the key is to cut spending without raising taxes. Goldman Sachs economist have found that a 1% cut in spending will led to a .6% increase in growth Raising taxes to GDP by 1% will cut growth by .9%. The multiplier effects are not what is normally expected. Paul Krugman, on the other hand, argues that any cut in stimulus would be "utter folly". The "folly seems to be the new trend in Europe.
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