The theoretical inconsistency of the expansionary austerity doctrine (reprise): an extension to the long run

Alberto Botta

No 15935, Greenwich Papers in Political Economy from University of Greenwich, Greenwich Political Economy Research Centre

Abstract: In this paper, we provide a critical analysis of the theory of the expansionary austerity (EAT). Our attention is on the theoretical weaknesses of the EAT, say the extreme circumstances and fragile assumptions under which expansionary consolidations might actually take place. We present a simple theoretical model that takes inspiration from both the post-Keynesian and evolutionary/institutionalist traditions. We first show that well-designed austerity measures hardly trigger off short-run economic expansions in the context of expected long-lasting consolidation plans (i.e. when adjustment plans deal with remarkably high debt-to-GDP ratios); when the so-called ‘financial channel’ is not operative (i.e. in the context of monetarily sovereign economies); when the degree of export responsiveness to internal devaluation is low. Even in the context of non-monetarily sovereign countries (see Eurozone countries), austerity’s effectiveness crucially depends on its highly disputable capacity to immediately stabilize fiscal variables. We then analyse some possible long-run economic dynamics. We emphasize the high degree of instability that characterizes austerity-based adjustments plans. Path-dependency and cumulativeness make the short-run impulse effects of fiscal consolidation of paramount importance to (hopefully) obtain any appreciable medium-to-long-run benefit. Should these effects be contractionary on the onset, the short-run costs of austerity measures can breed an endless spiral of recession and ballooning debt in the long run. If so, in the case of non-monetarily sovereign countries debt forgiveness may emerge as the ultimate solution to restore economic soundness. Alternatively, institutional innovations like those adopted since mid-2012 by the ECB are required to stabilize the economy, although not to prompt sustained recovery.

Keywords: Fiscal policy; Expansionary austerity theory; Post-Keynesian macro models; Evolutionary theory (search for similar items in EconPapers)
JEL-codes: E12 E61 E62 (search for similar items in EconPapers)
Date: 2016-11-04
New Economics Papers: this item is included in nep-pke
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