Larry Summers to Europe's rescue

I'm sure that the Europeans are absolutely giddy at the prospect of heeding advice from the man who managed the American economy under Barack Obama.

Lawrence Summers has jumped on the "growth" bandwagon that is sweeping Europe at the moment, giving in to the demands of citizens who don't want to lose their cradle to grave security despite the fact that there's no money left to pay for it.

Or, there is money, as long is it can be created out of thin air and paid back by future generations.

Summers writing in the Financial Times:

Treating symptoms rather than causes is usually a good way to make a patient worse. So it is in Europe. Its financial problems stem from lack of growth. In any financial situation where interest rates far exceed growth rates, debt problems spiral out of control. The right focus for Europe is on growth. In this context increased austerity is a step in the wrong direction.

Systematic comparisons of the experience of different European countries or more global comparisons at the IMF are salutary. They suggest that, when economies are constrained by demand and safe short-term interest rates are near zero, policy measures that reduce the deficit by 1 per cent have a multiplier of 1 to 1.5. This implies a 1 per cent reduction in a country's ratio of spending to GDP or an equivalent tax increase reduces its GDP growth rate by 1 to 1.5 per cent.

[...]
Sceptics will rightly wonder how a prescription for more spending by countries that already have trouble borrowing can be correct. The answer lies in the difference between borrowing by an individual and by a country. Normally, an individual helps his creditors by borrowing less, but a person who stops borrowing to finance commuting to work does his creditors no favour. Similarly, since for a country income is determined by spending, a country that pursues austerity to the point where its economy is driven into a downward spiral does its creditors no favour. Yes, there will ultimately be a need to raise retirement ages, reform sclerosis-inducing regulations and restructure benefit programmes. Phased in, commitments in these areas would be constructive. But the prospect for success, politically and economically depends on the restoration of growth.

Herein lies the fallacy being promoted in Europe and here in the United States; we can cut the budget later after we fix what we messed up.

Nonsense. As difficult as it is now to reduce the deficit and pare the debt down to a manageable size, politically speaking, it will only get harder to do so later. Every year we delay in fixing Medicare, for example, a trillion dollars is added in unfunded liabilities. Any pain experienced by voters now will be revisited upon them 2 or 3 fold 5 or 7 years from now when the Fed believes we'll be back to reasonable unemployment levels.

It is unrealistic to expect people to support "phased in" cuts to the budget when things are going relatively well. Why cut now, will be the question? In the end, people like Summers and Paul Krugman, and the socialist candidate in France Mr. Hollande just want to kick the can down the road and let others deal with the crisis created by policies that were destined to fail from the start.

I'm sure that the Europeans are absolutely giddy at the prospect of heeding advice from the man who managed the American economy under Barack Obama.

Lawrence Summers has jumped on the "growth" bandwagon that is sweeping Europe at the moment, giving in to the demands of citizens who don't want to lose their cradle to grave security despite the fact that there's no money left to pay for it.

Or, there is money, as long is it can be created out of thin air and paid back by future generations.

Summers writing in the Financial Times:

Treating symptoms rather than causes is usually a good way to make a patient worse. So it is in Europe. Its financial problems stem from lack of growth. In any financial situation where interest rates far exceed growth rates, debt problems spiral out of control. The right focus for Europe is on growth. In this context increased austerity is a step in the wrong direction.

Systematic comparisons of the experience of different European countries or more global comparisons at the IMF are salutary. They suggest that, when economies are constrained by demand and safe short-term interest rates are near zero, policy measures that reduce the deficit by 1 per cent have a multiplier of 1 to 1.5. This implies a 1 per cent reduction in a country's ratio of spending to GDP or an equivalent tax increase reduces its GDP growth rate by 1 to 1.5 per cent.

[...]
Sceptics will rightly wonder how a prescription for more spending by countries that already have trouble borrowing can be correct. The answer lies in the difference between borrowing by an individual and by a country. Normally, an individual helps his creditors by borrowing less, but a person who stops borrowing to finance commuting to work does his creditors no favour. Similarly, since for a country income is determined by spending, a country that pursues austerity to the point where its economy is driven into a downward spiral does its creditors no favour. Yes, there will ultimately be a need to raise retirement ages, reform sclerosis-inducing regulations and restructure benefit programmes. Phased in, commitments in these areas would be constructive. But the prospect for success, politically and economically depends on the restoration of growth.

Herein lies the fallacy being promoted in Europe and here in the United States; we can cut the budget later after we fix what we messed up.

Nonsense. As difficult as it is now to reduce the deficit and pare the debt down to a manageable size, politically speaking, it will only get harder to do so later. Every year we delay in fixing Medicare, for example, a trillion dollars is added in unfunded liabilities. Any pain experienced by voters now will be revisited upon them 2 or 3 fold 5 or 7 years from now when the Fed believes we'll be back to reasonable unemployment levels.

It is unrealistic to expect people to support "phased in" cuts to the budget when things are going relatively well. Why cut now, will be the question? In the end, people like Summers and Paul Krugman, and the socialist candidate in France Mr. Hollande just want to kick the can down the road and let others deal with the crisis created by policies that were destined to fail from the start.

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