Economic Ideas You Should Forget by Bruno S. Frey & David Iselin

Author:Bruno S. Frey & David Iselin
Language: eng
Format: epub
Publisher: Springer International Publishing, Cham

© Springer International Publishing AG 2017

Bruno S. Frey and David Iselin (eds.)Economic Ideas You Should Forget10.1007/978-3-319-47458-8_36

There Ain’t No Such Thing as a Free Lunch: The Myth of Expansionary Consolidations

Gebhard Kirchgässner1

(1)Universität St. Gallen, SIAW-HSG, Bodanstrasse 8, 9000 St. Gallen, Switzerland

Gebhard Kirchgässner

Email: [email protected]

When budget deficits become too large and public debt is increasing too fast, i.e., fiscal policy is no longer sustainable, fiscal consolidations become necessary. Public expenditure has to be reduced and/or taxes have to be raised. According to estimates of the International Monetary Fund (IMF), a 1 % of GDP fiscal consolidation reduces—on average—real GDP by about 0.5 % and raises the unemployment rate by about 0.3 % points. Thus, a major fiscal consolidation can lead to social problems, sometimes even to severe social unrest. The hope is, of course, that such a policy leads in the long run to a more sustainable fiscal policy accompanied by an economic upswing that helps to solve the social problems.

In their 2010 paper, Alesina and Ardagna presented a different view which goes back to considerations of Giavazzi and Marco in 1990. If private economic agents realise the budget cut and believe that the new, sustainable fiscal policy will continue, they might react by immediately increasing investment and/or consumption. Thus, in contrast to traditional wisdom, a fiscal contraction might be accompanied by an economic upswing or at least not by an economic contraction. They presented some examples for such a situation. This argument played a major role in the discussion about how EU member countries should behave during the European debt crisis; it supported the request for austerity policy.

A critical discussion of this paper showed that none of the examples was convincing; either the fiscal consolidation was not in an economic downswing or there were other factors as, for example, a strong devaluation which might have prevented a further downswing. The IMF and others, acknowledging the theoretical possibility of such a development, stated that there was no chance for such an effect in the current situation in Europe. Given the low interest rates, it cannot be accompanied by expansionary monetary policy. Moreover, if many countries undertake fiscal consolidations, the negative effect on GDP is magnified. In taking up the IMF’s arguments, the Economist concludes: “Most people believe that fiscal consolidations are helpful in the long run. Expecting them to be painless looks like wishful thinking.”

Economics is often called a “dismal science”. The reason for this is that economists typically tell the people that everything has its costs and benefits: “There ain’t no such thing as a free lunch.” That two economists propagate fiscal consolidations as a possibility for such a free lunch is at any rate astonishing.

There is, moreover, another aspect that is politically highly relevant. Fiscal consolidations are sometimes necessary but nevertheless painful. In many cases, poor people suffer the most. Take, for example, Greece. Between 2008 and 2013, unemployment rose from 7.8 to 27.5 %. An economist demanding a fiscal consolidation has to explain why he thinks that the sacrifice of the poor is unavoidable and, by this way, justified.

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