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June 23, 2010
Data turns Keynes upside down!
Lord Keynes must be rolling in his grave as the U.K. takes a page out of Ronald Reagan's economic recovery book. An emergency budget has been introduced that leans mostly on spending cuts to reduce the deficit.
Bloomberg reports that some economists see the spending cuts as spurring growth.
Governments have proven they can spur expansion by focusing their belt-tightening on spending cuts rather than tax increases, according to studies by Harvard University professor Alberto Alesina and Goldman Sachs Group Inc. economists Kevin Daly and Ben Broadbent. Memo to Obama...please read Mr. Reagan's speeches. He said the same thing 20 years ago In fact, it worked so well that the media had to drop the term "Reaganomics." Although, it must be noted that President Reagan was an unabashed patriot who fervently believed in individual liberty and freedom as opposed to soft tyranny, dependency and the welfare state.
There have been mountains of evidence in which cutting government spending has been associated with increases in growth, but people still dont quite get it, Alesina said in an interview. He made a presentation to European finance chiefs on the topic during their April meeting in Madrid.
Such a strategy in the past has also resulted in significant bond and equity-market outperformance, according to an April 14 Goldman Sachs report.
The key is an emphasis on cutting spending rather than raising taxes, said Goldman Sachs economists Broadbent and Daly in London. Lower spending means consumers and companies dont fear higher taxes, so demand accelerates. A smaller public sector also helps reduce borrowing costs and makes economies more competitive as fewer government workers lighten labor expenses.
In a study of 44 large fiscal adjustments in 24 advanced economies since 1975, Broadbent and Daly discovered that reducing expenditures by 1 percentage point a year boosted average annual growth by 0.6 percentage point. Raising the ratio of taxes to GDP by the same margin cut growth by an average 0.9 percentage point.
The equity markets of the countries that sliced spending beat those of other advanced nations by 64 percent during a three-year period, and their bond yields fell by more than if budget adjustments had been driven by tax hikes, according to the report.
A rigorous approach from governments gives investors much more confidence that policy-setting is meant to be serious, said Franz Wenzel, a strategist at AXA Investment Managers in Paris, which oversees the equivalent of more than $600 billion. That is what supports risky assets in general and equities in particular.