Blog Post

Effects of austerity revisited – how GDP surprised and why?

The debate about appropriate fiscal policy has been fluctuating since the onset of the financial crisis.

By: Date: March 22, 2013 Topic: European Macroeconomics & Governance

The debate about appropriate fiscal policy has been fluctuating since the onset of the financial crisis. In 2009 the emphasis was on coordinated stimulus but since the beginning of the euro crisis voices calling for consolidation have been louder and arguably also more influential than those who favour continued fiscal support. Lately, however, the pendulum has swung back to some degree in favour of the fiscal doves as austerity fatigue has set in and because the supposed resumption of growth as a result of increased confidence arising from improved public finances has failed to materialize. This change in the discussion has been influenced by a Blanchard and Leigh study (2013) arguing that fiscal multipliers are larger than previously thought. Furthermore in a recent piece De Grauwe’s and Ji’s (2013) questioned the wisdom of austerity in the form it has been conducted so far in Europe.

The issue is analyzed here using past European Commission forecasts for GDP growth in 2012. Firstly we look at the macroeconomic forecasts under which governments made their fiscal plans. Secondly, if growth differed from forecast, we study which demand components were responsible for this and to what degree the shortfall in growth is attributable to austerity.

Figure 1 presents growth past growth forecasts for selected countries.

Until May 2011, all countries except Portugal were forecast to exhibit positive growth in 2012, i.e. fiscal consolidation was estimated compatible with growth. Although the rate of expansion was projected low, the forecasts could have been used to justify the argument that instead of trying to accelerate growth, emphasis should be on putting public finances on a sustainable footing. Had forecasts been more pessimistic, arguments for relaxing austerity to avoid depressing output further might have been more numerous.

Figure 2 portrays how accurate the forecasts were.[1] It breaks down the GDP growth surprise to its components.[2]

Growth surprised negatively in all selected countries (this remains true if we use the November 2010 or November 2011 forecasts as the base). Forecasts for Greece and Italy missed the most, by -7.5 and -3.5 % respectively. A second common feature is that imports grew slower or decreased faster than expected in all countries except the UK, which reflects the widespread demand compression.

In other respects the economies can be divided broadly into three groups.

  • In Greece, Italy, Portugal and Spain, growth was slower than forecast mainly because of a decrease in domestic demand (particularly private consumption and investment)
  • For Ireland and the UK, slow export growth was the main factor
  • For France, Germany and the euro area 17 (EA-17), the decline was quite evenly spread between investment, private consumption, inventories and exports

What to make of these numbers? The stronger than expected decline in domestic demand in the Mediterranean countries could be interpreted as an underestimation of the negative effects of public consolidation. Nevertheless, this lesson does not seem to apply universally. In Ireland and the UK, two other countries with major consolidation programmes, domestic demand was secondary to slow export growth in explaining the growth shortfall.

The digression is difficult to explain by differently sized consolidation programmes as measured (admittedly narrowly) by the level of contribution of public consumption to GDP growth. Although consolidation by this measure was indeed non-existent in the UK (+0.6 %), the negative growth contribution of public consumption in Ireland (-0.7 %) was comparable to that in Portugal (-0.8 %) and Spain (-0.9 %) and larger than in Italy (-0.2 %). The ripple effects on other demand components, however, differed considerably. This analysis is only partial though because consolidation packages also included tax increases and reductions in benefits and public investment, which public consumption does not take into account.

Assuming that initial forecasts were unbiased, the data supports Giles’ (2013) thesis that disappointing growth in the UK was caused mainly by underperformance of the export sector.[3] Nevertheless, Wolf (2013) and other fiscal doves can still consistently argue that the external shocks should have been counteracted with a slower pace of fiscal consolidation.

The fact that the source of the shortfall in demand differs across countries points to more than one explanatory factor. Different private sector expectations, the structure of fiscal consolidation and idiosyncratic shocks, to name a few, arguably contributed to the heterogeneous forecast errors.

References

Blanchard, Olivier and Daniel Leigh, 2013. "Growth Forecast Errors and Fiscal Multipliers," NBER Working Papers 18779, National Bureau of Economic Research, Inc.

Giles, Chris, 2013, ”Osborne is too timid, not too austere”, Financial Times, March 13th

http://www.ft.com/intl/cms/s/0/e5e476e4-8b24-11e2-8fcf-00144feabdc0.html#axzz2NsVq0AD4

De Grauwe, Paul and Yuemei Ji. 2013, “Panic driven austerity in the eurozone and its implications”, VoxEU

Weale, Martin, 2013, “Balance of payments”, Speech at Warwick Economics Summit, 16th February

http://www.bankofengland.co.uk/publications/Documents/speeches/2013/speech635.pdf

Wolf, Martin, 2013, “Britain’s austerity is indefensible”, Financial Times, March 12th

http://www.ft.com/intl/cms/s/0/1670a3d2-880f-11e2-8e3c-00144feabdc0.html#axzz2NsVq0AD4


[1] We use here May 2011 as the base forecast. This is arbitrary to some degree, but the qualitative analysis that follows remains broadly the same also if we would have picked a different forecast.

[2] Domestic demand= private consumption +  public consumption + investment + change in inventories.

[3] See Weale (2013) for an analysis of the disappointing UK export performance.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic More by this author

Blog Post

The international effects of ECB’s monetary policy

What’s at stake: the literature on monetary policy spillovers is abundant of studies investigating the impact of the US Federal Reserve’s monetary policy announcements and actions on emerging market economies. More recently, economists have been investigating the effect of the ECB’s credit easing as well.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 24, 2017
Read about event More on this topic

Past Event

Past Event

Perspectives on Universal Basic Income

At this event, we discussed the possible benefits but also the possible disadvantages of Universal Basic Income.

Speakers: Grégory Claeys, Olli Kangas, Professor Philippe Van Parijs and Prof. Dr. Hilmar Schneider Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 12, 2017
Read article More on this topic More by this author

Blog Post

The forward guidance paradox

What’s at stake: the term “forward guidance” is used in economic jargon to describe central bank communications about the likely future path of policy rates. Standard monetary models imply that far future forward guidance has huge effects on current outcomes, and recent literature has been trying to reconcile this with reality.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: July 10, 2017
Read about event

Upcoming Event

Sep
7-8
09:00

Bruegel Annual Meetings 2017

The Annual Meetings are Bruegel’s flagship event. They offer a mixture of large public debates and small private sessions about key issues in European and global economics. In a series of high-level discussions, Bruegel’s scholars, members and stakeholders will address the economic policy challenges facing Europe.

Speakers: José Antonio Álvarez Álvarez, Agnès Bénassy-Quéré, Pervenche Béres, Jean Luc Demarty, Anna Ekström, Lowri Evans, Sandro Gozi, Peter Grünenfelder, Patrick Graichen, Reiner Hoffman, Levin Holle, Steffen Kampeter, Peter Kažimír, Emmanuel Lagarrigue, Steven Maijoor, Nathalie Moll, James Murray, Carlos Sallé Alonso, André Sapir, Dirk Schoenmaker, Mateusz Szczurek, Marianne Thyssen, Liviu Voinea, Johan Van Overtveldt, James Waterworth, Ida Wolden Bache and Guntram B. Wolff Topic: Energy & Climate, European Macroeconomics & Governance, Finance & Financial Regulation, Global Economics & Governance, Innovation & Competition Policy Location: Square - Brussels Meeting Centre
Read about event

Past Event

Past Event

Is there a way out of non-performing loans in Europe?

At this event we looked at the issue of non-performing loans in Europe. The event also saw the launch of the latest issue of "European Economy – Banks, Regulation and the Real Sector."

Speakers: Emilios Avgouleas, Giorgio Barba Navaretti, Giacomo Calzolari, Maria Demertzis, Martin Hellwig, Helen Louri and Laura von Daniels Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 6, 2017
Read article Download PDF More on this topic

External Publication

Review of EU-third country cooperation on policies falling within the ITRE domain in relation to Brexit

What is the possible future relationship between the EU and the UK in light of Brexit? The report provides a critical assessment of the implications of existing models of cooperation between third countries and the European Union on energy, electronic communications, research policy and small business policy.

By: J. Scott Marcus, Georgios Petropoulos, André Sapir, Simone Tagliapietra, Alessio Terzi, Reinhilde Veugelers and Georg Zachmann Topic: European Macroeconomics & Governance Date: July 5, 2017
Read about event

Upcoming Event

Sep
28
12:30

Unfinished business: The unexplored causes of the financial crisis and the lessons yet to be learned

At this event Tamim Bayoumi will present his upcoming book on the financial crisis, showing how how the Euro crisis and U.S. housing crash were, in fact, parasitically intertwined.

Speakers: Tamim Bayoumi, Maria Demertzis and Aerdt Houben Topic: European Macroeconomics & Governance, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article More on this topic More by this author

Blog Post

Eurozone or EU budget? Confronting a complex political question

This week’s European Commission reflection paper is the latest document to ponder a distinction between EU and euro-area budgets. But do we need to split the two, and what would each budget be used for? In this post, I present an analytical framework for assessing this ultimately political question

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: June 29, 2017
Read article More on this topic More by this author

Blog Post

Raising the inflation target: a question of robustness

In an unexpected move, the Federal Reserve Chair Janet Yellen has recently brought up the issue of raising the inflation target. This blog argues that an increase in inflation targets may prove to be beneficial in achieving price stability in the long run. This would increase the credibility of central banks in achieving inflation goals and stave off the distortionary effects of deflation.

By: Maria Demertzis Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More on this topic

Blog Post

Can EU actors keep using common law after Brexit?

English common law is the choice of law for financial contracts, even for parties in EU members with civil law systems. This creates a lucrative legal sector in the UK, but Brexit could make UK court decisions difficult to enforce in the EU. Parties will be able to continue using English common law after Brexit, but how will these contracts be enforced? Some continental courts are preparing to make judicial decisions on common law cases in the English language.

By: Uuriintuya Batsaikhan and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More on this topic More by this author

Blog Post

The size and location of Europe’s defence industry

There is growing debate about a common European military policy and defence spending. Such moves would have major economic implications. We look at the supply side and summarise some key facts about the European defence sector: its size, structure, and ability to meet a possibly increased demand from EU member states.

By: Alexander Roth Topic: European Macroeconomics & Governance Date: June 22, 2017
Read article More by this author

Parliamentary Testimony

House of Commons

Exiting the European Union Committee

On 19 April 2017 Zsolt Darvas appeared as a witness at the Exiting the European Union Committee, the House of Commons, United Kingdom.

By: Zsolt Darvas Topic: European Macroeconomics & Governance, House of Commons, Testimonies Date: June 20, 2017
Load more posts