An interesting counterfactual is how the eurozone economies would have performed if the ECB had implemented an aggressive communications and quantitative easing stategy. My guess: much, much better — just as easier money has helped offset US austerity. That is something to keep in mind as one read’s Daniel Gros’s defense of European austerity:
Economists like to point out that solvency has little to do with the ratio of public debt to today’s GDP, and much to do with debt relative to expected future tax revenues. A government’s solvency thus depends much more on long-term growth prospects than on the current debt/GDP ratio.
A reduction in the deficit today might lead in the short run to a fall in GDP that is larger than the cut in the deficit (if the so-called multiplier is larger than one), which would cause the debt/GDP ratio to rise. But almost all economic models imply that a cut in expenditures today should lead to higher GDP in the long run, because it allows for lower taxes (and thus reduces economic distortions).
Austerity should thus always be beneficial for solvency in the long run, even if the debt/GDP ratio deteriorates in the short run. For this reason, the current increase in debt/GDP ratios in southern Europe should not be interpreted as proof that austerity does not work.
Moreover, austerity has been accompanied by structural reforms, which should increase countries’ long-term growth potential, while pension reforms are set to reduce considerably the fiscal cost of aging populations. Such& reforms promise to strengthen the solvency of all governments that adopt them, including those on the eurozone’s periphery.
I would add that raising the eurozone tax burden further from already high levels is not automatically a long-run plus for growth. Too much of the region’s austerity was from tax hikes.