Sometimes when I write about the Eurozone, I get comments about how inappropriate it is to apply ‘an anglo-saxon model’ of how that economy works. I think the best translation of ‘anglo-saxon’ is Keynesian. In an important sense this is rubbish. All I am doing is using the framework that is used by most applied macromodellers everywhere. That framework says that if you have a large fiscal contraction like this
|Underlying Government Primary Balances: source OECD Economic Outlook|
without a large compensating relaxation in monetary policy, then you will get the stagnation in output that I showed at the top of this post, and a substantial increase in unemployment.
Can this scale of fiscal contraction in itself fully account for the second Eurozone recession? There are various ways of answering this question: see, for example, this work by Jordà and Taylor, or the analysis by Holland and Portes that uses a structural econometric model. A very recent paper (available here) by Ansgar Rannenberg, Christian Schoder and Jan Strasky does something different. It uses modified versions of three different DSGE models to analyse the impact of the Eurozone fiscal contraction from 2011 to 2013. One of these models is QUEST III at the European Commission, which Jan in‘t Veld used in analysis I described here. The other two are FiMod, developed by staff of the Deutsche Bundesbank and the Banco de Espana, and NAWM, the ECB’s New Area Wide Model. All very ‘anglo-saxon’!
The modifications the authors make to the models, and the details of their analysis, would probably only be of interest to inveterate macromodellers like me, so those who want to know more should read the paper. Here I will just quote the key conclusions:
“We find that fiscal consolidation caused a cumulative GDP loss of between 14% and 20% of annual baseline GDP over the 2011 to 2013 period in the Euro Area [EA], implying a cumulative multiplier between 1.5 and 2.2.” and “As a result, the simulated GDP effects of the EA’s fiscal consolidation are large, and would be more than sufficient to explain the recent recession in the EA.”
The idea that a large fiscal contraction shortly after a huge financial crisis would lead to a second recession is not the wild imagining of a group of ‘anglo-saxon’ economists, or a particular macroeconomic ‘school of thought’. It is just mainstream macroeconomics. And we must never forget that this is not the unfortunate cost of having to get debt down in a few periphery countries: as the chart above shows, this fiscal contraction occurred everywhere in the Eurozone. As the simulations described in this link (pdf) show, using the Belgian NIME model, these costs could have been largely avoided if the fiscal consolidation had been delayed until monetary policy was in a position to offset them. It is not just a predictable recession; it is a recession made by policymakers without good cause and therefore an entirely avoidable recession.