Austerity — a politically popular argument — only results in greater suffering

Paul De Grauwe and the Rehn of Terror

Paul Krugman, NYT

Nobody has taught me as much about the euro crisis as Paul De Grauwe, who brought to the fore a crucial point almost everyone was overlooking: the importance of self-fulfilling debt panics in countries that no longer have their own currencies. Now he has a new paper with Yuemei Ji following up on that insight, and offering yet more evidence of the incredible unwisdom of European economic policy.

What De Grauwe and Ji show is that the rush to austerity in Europe largely reflected the surge in sovereign debt spreads after Greece got in trouble; the bigger the spread, the harsher the austerity. But it turned out that the spreads didn’t reflect underlying fiscal fundamentals. De Grauwe had already made that point by comparing the UK with Spain; similar fiscal outlooks, wildly different borrowing costs. Now he has another piece of evidence, the spectacular decline in spreads once the ECB signaled its willingness to buy sovereign debt if necessary, thereby removing fears of a self-fulfilling liquidity crisis.

Meanwhile, all that austerity has taken a terrible toll. De Grauwe and Ji offer us yet another revealing scatterplot, using announced austerity measures in 2011:



But hey, Keynesian economics can’t be right, can it?

(More here.)