By Eric Heyer

To meet French commitments vis-à-vis Brussels to a general government deficit in 2012 of 4.5% of GDP, the French Prime Minister Francois Fillon announced a new plan to cut the budget by 7 billion euros. Will the plan, announced 7 November, be sufficient? Certainly not! So what new austerity plans should we expect in the coming months, and what impact will they have on growth in 2012?

In early October 2011, among the points we indicated in our forecast dossier was that, of all the finance bills approved in Europe, no major country has met its commitment to reduce the deficit.

This will be the case in particular of Italy and the UK, which could face a gap of between 1.5 and 2 percentage points between the final public deficit and their commitment. In the case of France and Spain, the gap will probably be 0.6 and 0.7 point, respectively. Only Germany will come very close to its commitments (Table 2).

Unlike in previous years, the implementation of these commitments would seem probable: in an uncertain financial context, being the only State not to comply with its promise of fiscal consolidation would be punished immediately by more expensive financial terms on the repayment of its debt.

This will therefore require the adoption of new austerity plans in the coming months. But by attempting to reduce their deficits too early, too quickly and in a synchronized fashion, the governments of the European countries are running the risk of a new downturn. Indeed, as we noted in a recent study, tightening budget policy during a cyclical downturn in all the European countries and doing so in a situation of a persistent “liquidity trap” is contributing to the formation of a strong multiplier, close to unity.

How many billion euros will be targeted by the next fiscal savings plans? What impact will they have on economic growth? Several possible cases were considered.

Case 1: Each country respects its commitment alone
In order to isolate the impact on growth of the national savings plan and those of the partners, we have assumed that each country meets its commitment alone. Under this assumption, the effort would be significant in Italy and the UK, which would present new austerity plans for, respectively, 3.5 and 2.8 points of their GDP (56 and 48.7 billion euros). France and Spain would implement an austerity plan two to three times smaller, about 1.2 points of GDP, representing 27 and 12.1 billion euros, respectively. Finally, the German savings plan would be the weakest, with 0.3 point of GDP (7 billion euros) (Table 1).

These different national austerity plans, taken in isolation, would have a non-negligible impact on the growth of the countries studied. With the exception of Germany, which would continue to have positive growth in 2012 (0.9%), this kind of strategy would plunge the other economies into a new recession in 2012, with a decline in their GDP ranging from -0.1% for Spain to -2.9% for Italy. France would experience a decline in activity of -0.5% and the British economy of -1.9% (Table 2).

Case 2: All the EU countries meet their commitment

Of course, if all the major European countries were to adopt the same strategy at the same time, then the savings effort would be greater. It would amount to about 64 billion euros in Italy and 55 billion euros in the UK, accounting for 4 and 3.2 percentage points of GDP, respectively. The additional effort would be about 2.0 percentage points of GDP for France and Spain (respectively 39.8 and 19.6 billion euros) and 0.9 GDP point for Germany (22.3 billion euros). In total for the five countries studied, the cumulative savings effort would represent more than 200 billion euros in 2012.

The shock on the activity of these countries would be powerful: it would cause a violent recession in 2012 for some countries, with a fall in GDP of -3.9% in Italy (against -5.1% in 2009), and -2.6 % in the UK (against -4.9% in 2009). France would be close to recession (-1.7%), as would Spain (-1.5%), while German GDP would decline slightly (-0.3%).

Case 3: Only the countries in the euro zone meet their commitment

As the UK has already implemented a substantial austerity program, and given that their constraints in terms of the deficit are more flexible than those of countries in the euro zone, we assumed that only the major countries in the euro zone complied with their commitments on the public deficit. Under these conditions, the cumulative savings effort would represent more than 130 billion euros in 2012, almost half of which would be from Italy alone (61.7 billion).

The recessionary shock would thus be focused on the euro zone, with a recession in all the countries studied except Germany (0.1%). The British economy would avoid a new period of recession (0.5%), but it would not meet the target of 6.5 percentage points of GDP for the public deficit, which would come to 8.2 GDP points.

By Jérôme Creel and Francesco Saraceno

Too long and too technical, the final declaration of collective action of the G20 Summit in Cannes shows that no clear and shared vision of the economic and financial turmoil that is rocking the global economy has emerged at the Summit. And as Seneca reminds us, the disappointment would have been less painful if success had not been promised in advance.

According to the official announcements, the disappointment was palpable at the end of a G20 summit in which no significant progress was achieved ​​on the most important issues of the moment, the revival of growth in particular. The crucial issues of agriculture and finance gave rise simply to declarations of intent, with a reminder of the commitments made on these … in 2008! The disappointment must be kept in perspective, however, as the G20 is primarily a forum for discussion rather than for decisions. Indeed, what remains of the commitments made in April 2009 by the G20 in London, mired in global recession? The expansionary fiscal policies? Forgotten, as a result of the public debt that they have produced – debt, by the way, that was perfectly predictable. Strengthened financial regulation? Repeatedly trotted out, but still not implemented, despite the determination displayed in Paris on 14 and 15 October 2011. The desire to avoid protectionism? Barely mentioned, nor did this succeed in preventing the outbreak of 36 trade disputes brought before the WTO, including 14 involving China, the EU and / or the United States. All that remains is a monetary policy that is “expansionary as long as necessary”, in the words of the pre-Summit statements. So does the fate of the international monetary system depend simply on the good will of the central bankers, independent as they are?

The meeting was also troubled by the crisis hitting the euro zone, which virtually forced off the agenda such important issues as the resurgence of protectionism, which was relegated to paragraphs 65 to 68 of a 95-paragraph document. At Cannes, the emerging economies and the US were spectators of a drama unfolding between Paris, Berlin, Rome and Athens.

The crisis hitting the euro zone is a result of the heterogeneity of its constituent countries, much as the financial crisis triggered in 2007 was a result not just of a lack of financial regulation but also of the increasing heterogeneity between mercantile countries and countries presumed to be the El Dorados of investment, on the one hand China and Germany, and on the other, the United States and Ireland. This European heterogeneity, one of four deficiences of the euro zone, has led countries with a surplus in their current accounts to finance countries running a deficit. Alone, and with its priority on the fight against inflation imposed by the Treaty of the EU, the ECB is unable to promote convergence within the euro zone. However, in the short term it can end the crisis in the euro by agreeing to provide full coverage of public debts in the euro zone (see [1], [2] or [3]), and by significantly increasing its purchases of government debt in Europe. This would maintain European financial stability and perhaps generate inflationary expectations, thereby helping to lift Europe’s economy out of the liquidity trap in which it has been mired since the beginning of the financial crisis. Note that despite its activism, the US Federal Reserve has not so far managed to create such expectations and remains caught in the same kind of liquidity trap.

In the longer term, it is necessary to review European economic governance. The active use of economic policy in the United States and China contrasts with the caution displayed by the ECB and with the European reluctance to pursue expansionary fiscal policies, and more generally with the decision to build European economic governance on a refusal of discretionary policies. It would be desirable for the ECB, while preserving its independence, to be able to pursue a dual mandate on inflation and growth, and for the rules that discipline fiscal policy to be “smarter” and more flexible.

Giving the economic policy authorities an opportunity to implement discretionary policies should not mean forgetting about the risks posed by the absence of a coordinated approach, which may lead the US Congress to threaten unilateral compensatory taxes on goods imported from countries whose currency is undervalued. This move is evoking the specter of protectionism, and the G20 countries should consider a mechanism to coordinate policy so as to avoid the trade wars that are already being more or less explicitly declared.

Furthermore, a currency war does not seem to be an effective way to protect our economies: the under-or overvaluation of a currency is a complex concept to apply, and the impact of a currency’s value on exports and imports is made very uncertain by the international fragmentation that characterizes the production of goods and services. Rather than employing a defensive policy, it is definitely better to substitute an active industrial policy to take advantage of new technological niches that create business and jobs.

Finally, for words to have real meaning – to “build confidence and support growth” in the advanced economies and “support growth” while “containing inflationary pressures” in the emerging economies (G20 Communiqué, Paris, 14-15 October 2011) – we must challenge the “contagion of fiscal contraction” that is now shaking the euro area and, rather than an additional phase of rigor, put recovery plans on the agenda in the advanced economies while interest rates are still low. These plans must be targeted in order to generate growth and not jeopardize the solvency of public finances: it is thus necessary to encourage public investment. To maximize their overall impact, these plans need to be coordinated, including with the actions of the central banks, so that the latter can support them by maintaining low interest rates. The Summit in November 2011 was very timely for this kind of coordinated approach to emerge. Unfortunately, it didn’t.

By Catherine Mathieu and Henri Sterdyniak

By their very nature, states with monetary sovereignty should renounce their AAA rating: indeed, what is the logic behind having the rating agencies rate a state whose default is rendered impossible by its ability to create its own money? To avoid dependence on the rating agencies and put an end to the crisis in Europe, the Member States of the euro zone must recover their monetary sovereignty through the joint, virtually complete guarantee of their public debts.

Since 1945, no developed country has defaulted on its debt. There was no risk on the debt, since the states borrowed in their own currency and could always obtain financing from their central bank. The developed countries enjoyed “monetary sovereignty”. This is still the case today for Japan (which enjoys 10-year loans at 1% despite a debt of 210% of GDP), the United States (which borrows at 2% with a debt of 98% of GDP), and the United Kingdom (which borrows at 2.5% with a debt of 86% of GDP).

Banks and insurance companies cannot function if they do not have risk-free assets and if they have to guard against the failure of their own state, which is of course impossible: the amounts involved are enormous, and government securities serve to guarantee banking and insurance activities. The banks and insurance companies could not accumulate enough capital to withstand the bankruptcy of their own country or multiple euro zone countries. As we can see today with the sovereign debt crisis in the euro zone, such a requirement would lead to the general paralysis of the banking system.

It is fundamentally absurd that the rating agencies rate a state with monetary sovereignty, as if its default were an option worth considering. States with monetary sovereignty should renounce their AAA rating: by their nature, their debt is risk-free because it is guaranteed by the central bank’s power to create money.

The euro zone countries have lost their “monetary sovereignty”: under the Treaty of the European Union, the European Central Bank has no right to finance Member States, and the States are not bound by joint liability. The financial markets noticed this in mid-2009, and suddenly uncontrollable speculation erupted, targeting the most fragile countries in the zone: first Greece, Portugal, and Ireland, which had the fastest growth before the crisis, but will have to change their growth pattern, and then, like dominos, Italy, Spain, and even Belgium. Today, Belgium has to pay an interest rate of 3.8%, Spain 5.2% and Italy 5.6%, compared with 2.6% in France and just 1.8 % for Germany. Greece, Ireland, and Portugal are now in the situation that the developing countries faced yesteryear: their debts have become risky assets subject to high risk premiums, and they are being brought under the yoke of the IMF.

The workings of the financial markets could completely paralyze fiscal policy. When a country enjoys monetary sovereignty, then in a recession the central bank can lower its maximum interest rate and if necessary commit to keeping it low in the long term; the state increases its deficit, but the low interest rates prevent the debt from snowballing; and it pushes exchange rates lower, which boosts activity. Since the debt is guaranteed by the creation of money, there is no risk of bankruptcy, and thus no reason to have to constantly reassure the markets. The central bank, by maintaining long-term rates at low levels in a recession, ensures that fiscal policy is effective. Fiscal policy does not need to worry about the markets. This is still the strategy of the United States today.

In the euro zone, the risk is that in the future a country could no longer increase its deficit for fear that the agencies might downgrade its rating and interest rates would then soar. The countries are therefore condemned to prove their virtue so as to appear as wise as Germany in the eyes of the markets. This renders their fiscal policy impotent, and their economic situation spins out of control (see, for example, The impossible programme of the candidates for the presidential election). The public debt becomes a permanent risk factor, since the states are at the mercy of the markets’ insatiable appetite. Any economic policy should of course be assessed while taking into account the views of the markets. Yet the markets have no special competence in macroeconomics. They impose austerity policies during a recession and then turn around and complain about the lack of growth – which is exactly what they are doing today with respect to the euro zone in general, and Italy and Greece in particular. They are promoting free market reforms such as cutting social welfare programs or the number of teachers. For countries to retain the ability to regulate their economic activity, the risk of default needs to be zero.

The euro zone must thus choose between dissolution and a reform that would guarantee the public debt of the Member States, which would re-gain their “monetary sovereignty”. European public debts should become risk-free assets, compensated at low rates but guaranteed in full (by European solidarity and fundamentally by the ECB). This is the only way to maintain the independence of fiscal policy, which is essential given the disparities in Europe and the loss by each country of its monetary and exchange rate instruments.

The functioning of the euro zone was not thought through at the time of its creation, particularly with respect to the trade-off between “autonomy of fiscal policy / single currency / monetary sovereignty”. Joint liability creates a moral hazard problem, as each country can increase its debt without limit, but a lack of a guarantee leaves the field open to the play of the financial markets, which are constantly on the lookout. The guarantee cannot be limited to countries that meet the automatic rules, which is unwarranted economically and fails to comply with the Stability Pact. It should be automatic and total. To avoid moral hazard, the European Treaty should include a provision for the extreme situation where a country carries out an unsustainable fiscal policy, in which case the new debt of the country would no longer be guaranteed – but this should never come to pass.

Freed of the need to reassure the markets, the euro zone countries could engage in differentiated but coordinated fiscal policies, with their main objective being to ensure a return to a satisfactory level of employment consistent with low inflation.

By Eric Heyer

Among the savings plans announced on 24 August 2011 by French Prime Minister François Fillon figures a change to the system of tax reductions on overtime hours and their exemption from social contributions,[1] a scheme that has been in force in France since 1 October 2007. This provides an opportunity to take another look at some of the main conclusions of the work carried out by the OFCE (French version) on this subject.

1 – An article to be published soon in the Oxford Review of Economic Policy[2] explains how the impact of this scheme will differ depending on the position of the economy in the cycle at the time the measure is applied.

• In a favourable economic climate, an increase in working hours prompted by lower labour costs and the elimination of payroll taxes would seem appropriate. The measure is of course not funded (the public deficit deteriorates), and financing it through higher levies would radically change its nature, even though this would not call into question its positive impact on employment and unemployment.
• However, this measure is poorly suited to the kind of economic downturn that the French economy is going through today. In a situation of mass unemployment, an increase of 1% in working hours has a negative impact on employment (-58,000 jobs at 5 years and -87,000 at 10 years). The unemployment rate would increase slightly (0.2 point at 5 years, 0.3 point at 10 years). The measure would have a small impact on growth (0.2 point at 5 years and 0.3 point at 10 years) and is not funded: the deficit would deteriorate by 0.5 point at 5 years (0.4 point at 10 years).

2 – This corroborates the results of a recent study published in Economie et Statistique[3]. The authors examined data on 35 sectors of the French economy and estimated that a 1% increase in overtime would destroy about 6,500 jobs in the commercial sector (i.e., 0.04% of commercial jobs), three-quarters of which would be temporary jobs.

Thus, in a context of a severe economic crisis, it seems that an incentive to work longer hours would hurt employment, especially temporary employment.

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[1] The government decided to reintegrate overtime hours into the general schedule of tax reductions while maintaining specific advantages on taxes and social welfare charges. Concretely, this measure will not change anything for employees: net remuneration will not be reduced, and income tax will not be increased. As for employers, they will continue to benefit from exemptions on charges for declared overtime hours, but will see smaller breaks on charges on low wages. This will take effect next January 1^st and, according to the government, will generate 600 million euros in revenue from additional social contributions.

[2] Heyer É. (2011), “The effectiveness of economic policy and position in the cycle: The case of tax reductions on overtime in France”, Oxford Review of Economic Policy, forthcoming.

[3] Cochard M., G. Cornilleau and É. Heyer (2011): “Les marchés du travail dans la crise”, Economie et Statistiques, no. 438-440, June.

By Jean-Paul Fitoussi, Gabriele Galateri di Genola and Philippe Weil

A spectre is haunting Europe – the spectre of sovereign default. All the powers of old Europe have entered into a holy alliance to exorcise this spectre: Brussels and Frankfurt, Angela Merkel and Nicolas Sarkozy, French socialists and German Christian Democrats. Churchillian doctors, they prescribe blood, sweat and tears – fiscal consolidation, tax increases and spending cuts. They swear, for the umpteenth time, that they will never surrender: Greece will be saved, Italy and Spain will not be abandoned and the rating of France will not be downgraded. In the face of adversity, they assure us that what cannot be achieved by austerity can be achieved by more austerity. An epidemic of holier-than-thou fiscal virtue is spreading throughout Europe and is fast transforming a series of uncoordinated fiscal retrenchments into a euro-wide contraction with dire implications for growth and employment.

To be sure, eurozone policymakers are in a maddening situation. The threat to monetise public debt, which in the old days could be waved by each country to remind investors it need not ever default outright, has been removed from national arsenals. No one knows for sure whether it will ever be brandished from Frankfurt or if European treaties even allow it. Eurobonds would have every economic merit but they hurt Germany which, having been left on its own to finance reunification, is understandably cold towards die Transfer-Union. Creating separate northern and southern euro areas would probably precipitate the end of the single market – and where would France fit? Wide-ranging fiscal reform designed to increase tax revenue equitably, while sorely needed, is a pipe dream: it requires elusive European co-ordination in an area in which the temptation to compete is strong and it is best done at its own pace – not under the pressure of fickle market sentiment or rising sovereign spreads.

Add to this powerlessness the terrifying failure of the old engine of European policymaking (putting the cart before the horse in the hope that the cart will conjure up the horse) and you will understand the ghoulish visions gripping our leaders. Monetary union has not begotten the expected fiscal union. Imposing, as a substitute, austerity plans from Brussels or Frankfurt, or racing to be first to impose “golden rule” constitutional strictures on parliaments that should remain sovereign in fiscal matters is stoking the fire of civil unrest. The English Civil War and American Revolution were ignited by much less. It would be wise to recall, as John Hampden did in contesting the Ship Money tax levied by Charles I, that what leaders have no right to demand, a citizen has a right to refuse.

Yet Europe’s fate is not sealed. The spectre of sovereign default and rising spreads in Italy, Spain, Belgium and other countries can be chased away in one fell swoop and the panic of contractionary fiscal policies can be stopped. National governments must simply take out of their fiscal armoury the weapon that has served them so well in war and peace alike: forced borrowing.

It consists in coercing taxpayers to lend to their government. California did this in 2009 when it added a premium to the income tax withheld from paychecks, to be repaid the following year. In France, the first Mitterand government forced rich taxpayers to fund a two-year bond issue – and both the US and UK have used moral suasion in patriotic sales of war bonds. Compulsory lending is an unconventional weapon but it is high time it be used, even on a small scale, to remind investors that sovereigns are not private borrowers: they need never default because they can always force-feed debt issues to their own residents.

Central banks have been bold and dared resort to unconventional policies to respond to the exceptional circumstances of this crisis. Large sovereign borrowers should be as defiant and intrepid. The invaluable asset of fiscal sovereignty guarantees that their public debt is completely risk-free in nominal terms. Investors who buy sovereign credit default swaps against the spectre of French or Italian default are wasting their money. Policymakers rushing to austerity should wake up from their nightmare and save growth and employment before it is too late.

Jean-Paul Fitoussi is former president and Philippe Weil is president of OFCE, the Observatoire français des conjonctures économiques in Paris. Gabriele Galateri di Genola is president of Generali. The views expressed are their own.

Copyright The Financial Times Limited 2011

By Eric Heyer

The proper framework for analyzing the French economy is a large economy that is not very open, and not a small open economy: the country’s economic situation has deteriorated sharply and is still far from its equilibrium position (mass unemployment, the existence of excess capacity), and its European neighbours are adopting identical approaches to fiscal policy. Under these conditions, everything indicates that the fiscal multipliers are high. The theoretical debate about the value of the multiplier and the role of agents’ expectations must therefore give way to the empirical evidence: the multipliers are positive and greater than one.

Following a deep recession, the most suitable method for making a forecast of short-term activity (2 years) is to evaluate the spontaneous return of the economy (speed and magnitude) to its equilibrium or potential level, but also and above all to quantify the impact of exogenous shocks (commodity prices, economic policy, etc.) on its spontaneous trajectory.

In our last forecast, we reported that the French economy has a significant rebound potential: corresponding to spontaneous growth of nearly 4% per year in 2011 and 2012, this would allow the economy, four years after the start of the crisis, to make up the output gap built up during that period.

Two exogenous shocks will slow down the country’s return to its potential level. The first involves the soaring prices of raw materials: this shock will mainly hit households and will weigh on their purchasing power and curtail their spending. This mechanism, which is also at work in the other Western countries, will cause a slowdown in their economies and hence their demand for French output. In aggregate, this purchasing power shock will cut the growth of the French economy by 1 point during the period 2011-2012. The second shock is related to fiscal policy: from 2011 onwards, the large (and small) developed countries, in the face of mounting debt and expanding government deficits, will be implementing policies of fiscal restraint. The generalization of this strategy will also put the brakes on economic growth; its impact is estimated at 2.8 percentage points of GDP during the years 2011-2012.

While there is relative agreement on evaluating purchasing power shocks, this is not the case for the impact of fiscal policy on economic activity.

What is the value of the fiscal multiplier?

Economic thought has been divided since the Great Depression over how to assess the impact of fiscal policy. Two major theoretical schools in the history of economic thought are at odds over the expected short-term impact of fiscal policy on economic activity.1 On the one hand, the “Keynesian” school holds that an increase of one percentage point of GDP in public spending (or an equivalent decrease in taxes) should result in an increase in GDP of more than one point. This is known strictly as the Keynesian multiplier effect. On the other hand, there are a number of theoretical arguments that question the ability of fiscal policy to generate a more than proportional increase in GDP. Within this opposing school, it is then necessary to distinguish between those in favour of a positive fiscal multiplier (albeit less than one) and those in favour of a negative fiscal multiplier; in the latter case, we are speaking strictly of anti-Keynesian fiscal multipliers.

Many empirical studies have attempted to settle this theoretical debate. A review of the literature on this subject tells us that the fiscal multiplier is always positive, and that the following situations push it higher:

1. The budget policies of the partner countries are synchronized;
2. The instrument used relies more on public expenditure rather than taxation (Haavelmo, 1945);²
3. Monetary policy is ineffective (IMF, 2010).³

In a recent article, the OFCE highlighted a fourth factor, which concerns the position in the economic cycle: the multiplier is higher when the economy is at the bottom of the cycle.

What can we say about the current economic situation?

The implementation of austerity policies in all the European countries (criterion 1), focused on reducing public expenditure (criterion 2), and acting in a situation of a persistent “liquidity trap” (criterion 3) describes the context for a high multiplier.

Only an assumption that the economic crisis did not simply cause a drop in production but also may have had a strong impact on the economic potential of the euro zone economies could render the current strategy of fiscal consolidation optimal (criterion 4): based on this assumption, the rise in structural unemployment would be identical to that of actual unemployment, and the fiscal multipliers would be low in the short term and zero in the long term.

If on the other hand the growth potential of the economies did not significantly change during the crisis, then this strategy would lose its apparent effectiveness, which would confirm the relevance of the first three criteria and strengthen the impact of the fiscal consolidation.

On this crucial point, the strong stimulus imparted by economic policy renders any evaluation of the economy’s new potential path more hypothetical and makes more complex the choice of a policy to end the crisis as well as the tempo of policy implementation. In any case, the violence of the initial shock can, it seems, lift any ambiguity about the case of the developed countries: even if it were agreed that this crisis has had a powerful impact on the economy’s growth potential, this would still not cancel out the overcapacity generated by the crisis over three years.

It is also possible to enrich the analysis by approaching it this time from the perspective of unemployment rather than production: unemployment rose brutally and spectacularly from the very start of the crisis, from 7.2% in early 2008 to 9.3% in late 2010. This increase in unemployment cannot be regarded as an increase in equilibrium unemployment: during this period, there were no significant changes in labour market institutions or practices, i.e. the main determinants of equilibrium unemployment. In the short term equilibrium unemployment could of course have been modified by a poor sector allocation of capital and labour resources. Some reallocation may also result from reduced productivity. But in any case there is no evidence of a lasting increase in equilibrium unemployment. The situation today is indeed a situation of involuntary unemployment as compared to what we could have seen, without inflation, with the full use of the available workforce.

Under these conditions all the evidence indicates that the multipliers are high: the country’s economic situation has deteriorated sharply and is still far from its equilibrium position (mass unemployment, the existence of excess capacity); monetary policy has little bite; and all the developed countries are in the same configuration and will therefore carry out the same policy.

The proper analytical framework is therefore that of a large, not very open economy, and not that of a small open economy. The theoretical debate about the value of the multiplier and the role of agents’ expectations must therefore yield to the empirical evidence: the multipliers are positive and greater than one.

A simulation of a neutral budget policy indicates that the choice of fiscal consolidation proposed by the developed countries will thwart the start of a virtuous circle: without it, growth in “the Hexagon” would have been higher by 1.7 points in 2011 and 1.1 points in 2012 (Table 1). This would have allowed the unemployment rate to fall significantly (-1.5 point), eventually to 7.8% by 2012, close to the level prevailing before the crisis. The general government deficit would also have benefited from the boost in activity: it would have declined, although certainly less than in the case of the austerity policies set out (5 GDP points), reaching 5.6 GDP points in 2012 (Table 1). By raising the unemployment rate by 1.5 points compared to the baseline, i.e. the situation without a policy of fiscal restraint, the cost of a reduction of 0.6 GDP point in the general government deficit seems extremely high.

1. In the long term, the effectiveness of fiscal policy vanishes. [↩]
2. Haavelmo T. (1945), “Multiplier effects of a balanced budget”, Econometrica, vol. 13, no. 4, October, pp. 311-318. [↩]
3. IMF (2010), “Recovery, Risk, and Rebalancing”, World Economic Outlook, Chapter 3, October. [↩]