Can austerity trigger growth?
New research shows austerity can stimulate economic growth by calming bond markets, which lowers interest rates and promotes investment.
There's a new voice in the fierce debate about whether we need fiscal responsibility ahead of economic stimulus by government. It is that of Italian-born Harvard Professor Alberto Alesina. He has done empirical research on those countries which applied fiscal tightening, and which saw economic growth follow. He found nine good matches (and some non matches).
Alesina also uses psychological, as opposed to purely mechanistic, accounts of the dynamic response to fiscal tightening, arguing that economic players change their responses when they see governments making fiscal responsibility a priority.
Alesina argues that austerity can stimulate economic growth by calming bond markets, which lowers interest rates and promotes investment. In addition, he says, deficit-cutting reassures taxpayers that more wrenching fiscal adjustments won't be needed later. That revives their animal spirits and their spending. Alesina says that as a way to shrink deficits, spending cuts are better for growth than raising taxes.
This bears massively on George Osborne's decision to prioritize measures to cut the debt and the deficit, rather than follow the voices calling for more borrowing-induced government spending to sustain and boost economic activity. If Alesina is right, Osborne will be seen in retrospect to have made the right decision.
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