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Has Austerity Been Vindicated?

A correlation between fiscal retrenchment and economic growth tells us nothing about the underlying relationship between the two. This should be borne in mind in light of new research suggesting that austerity may well be the right policy in a recession.

LONDON – Harvard University Professor Alberto Alesina has returned to the debate on budget deficits, austerity, and growth. Back in 2010, Alesina told European finance ministers that “many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run” (my italics). Now, with fellow economists Carlo Favero and Francesco Giavazzi, Alesina has written a new book entitled Austerity: When It Works and When It Doesn’t, which recently received a favorable review from his Harvard colleague Kenneth Rogoff.

New book, old tune. The authors’ conclusion, in a nutshell, is that “in certain cases the direct output cost of spending cuts is more than compensated for by increases in other components of aggregate demand.” The implication is that austerity – cutting the budget deficit, not expanding it – may well be the right policy in a recession.

Alesina’s previous work in this area with Silvia Ardagna was criticized by the International Monetary Fund and other economists for its faulty econometrics and exaggerated conclusions. And this new book, which analyzes 200 multi-year austerity plans carried out in 16 OECD countries between 1976 and 2014, will also no doubt keep the number crunchers busy.

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