Do we need more or less fiscal austerity in the eurozone?

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Do we need more or less fiscal austerity in the eurozone?

Publishing date: 08 February 2012
Authors: Guntram B. Wolff

Do we need more or less fiscal austerity in the eurozone? The answer is simple: it depends on the country and its economic circumstances.

Let's first do away with some fairy tales. No: fiscal consolidations are not expansionary. The few studies that claim to prove expansionary fiscal consolidations typically relate to very specific circumstances with strong external growth and exchange rate adjustments. All these conditions are not in place in the euro area. But also no: from an economic point of view, fiscal consolidations cannot be self-defeating. A reduction of public spending will typically result in a reduction in GDP but an even greater reduction in debt. At any reasonable multiplier, the deficit to GDP as well as the debt to GDP ratio will be lower compared to the case of no fiscal consolidation. Expenditure cuts thus do reduce fiscal vulnerability and are not self-defeating.

So should countries that are in a recession and face market pressure always enact a fiscal consolidation? That essentially depends on three things.

First, is the external borrowing position of the country sustainable? In the case of Greece, the current account deficit of almost 10% in 2011 suggests that domestic demand is still excessive and further cuts seem unavoidable. Avoiding fiscal consolidations will only sustain excessive demand and increase borrowing from abroad leading to more political and market pressure.

Second, does the economy have the capacity to grow externally? Again, the absence of significant price adjustments in Greece suggests that export growth is unlikely to pick up soon.

Replacing the external demand with internal demand created by large fiscal deficits will only delay the adjustment and increase the dependence of Greece on external funding.

Third, there is a social dimension. Fiscal cuts hurt people and lead to unemployment. If such cuts render the ability to reform the country impossible, it may be preferable to delay fiscal adjustment, a point made by my colleague Jean. But we should push this argument further:

Ultimately it means that fiscal transfers may be needed in monetary union if political, social and economic stability is the highest priority. Fiscal union is still incomplete. The situation is certainly different in every country of the euro area.

About the authors

Guntram B. Wolff

Guntram Wolff is a Senior fellow at Bruegel. He is also a Professor of Economics at the Université libre de Bruxelles (ULB).

From 2022-2024, he was the Director and CEO of the German Council on Foreign Relations (DGAP) and from 2013-22 the director of Bruegel. Over his career, he has contributed to research on European political economy, climate policy, geoeconomics, macroeconomics and foreign affairs. His work was published in academic journals such as Nature, Science, Research Policy, Energy Policy, Climate Policy, Journal of European Public Policy, Journal of Banking and Finance. His co-authored book “The macroeconomics of decarbonization” is published in Cambridge University Press.

An experienced public adviser, he has been testifying twice a year since 2013 to the informal European finance ministers’ and central bank governors’ ECOFIN Council meeting on a large variety of topics. He also regularly testifies to the European Parliament, the Bundestag and speaks to corporate boards. In 2020, ranked him one of the 28 most influential “power players” in Europe. From 2012-16, he was a member of the French prime minister’s Conseil d’Analyse Economique. In 2018, then IMF managing director Christine Lagarde appointed him to the external advisory group on surveillance to review the Fund’s priorities. In 2021, he was appointed member and co-director to the G20 High level independent panel on pandemic prevention, preparedness and response under the co-chairs Tharman Shanmugaratnam, Lawrence H. Summers and Ngozi Okonjo-Iweala. From 2013-22, he was an advisor to the Mastercard Centre for Inclusive Growth. He is a member of the Bulgarian Council of Economic Analysis, the European Council on Foreign Affairs and advisory board of Elcano. He is also a fellow at the Kiel Institute for the World Economy.

Guntram joined Bruegel from the European Commission, where he worked on the macroeconomics of the euro area and the reform of euro area governance. Prior to joining the Commission, he worked in the research department at the Bundesbank, which he joined after completing his PhD in economics at the University of Bonn. He also worked as an external adviser to the International Monetary Fund. He is fluent in German, English, and French. His work is regularly published and cited in leading media.