Learning About Growth from Austerity

Policymakers (and perhaps financial markets) may have believed that central banks would provide an adequate bridging function through aggressive unconventional monetary policy designed to hold down short- and long-term interest rates. Certainly central banks have played a critical role. But central banks have stated that they do not have the policy instruments to accelerate the pace of economic recovery.

Among the costs and risks of their low-interest-rate policies are a return to the leveraged growth pattern and growing uncertainty about the limits of a central bank’s balance-sheet expansion. In other words, will the elevated asset values caused by low discount rates suddenly reset downward at some point? No one knows.

Countries are subject to varying degrees of fiscal constraint, assuming (especially in the case of Europe) a limited appetite for unlimited, unconditional cross-border transfers. Those that have some flexibility can and should use it to protect the unemployed and the young, accelerate deleveraging, and implement reforms designed to support growth and employment; others’ options – and thus their medium-term growth prospects – are more constrained.

All countries – and policymakers – face difficult choices concerning the timing of austerity, perceived sovereign-credit risk, growth-oriented reforms, and equitable sharing of the costs of restoring growth. So far, the burden-sharing challenge, along with naive and incomplete growth models, may have contributed to gridlock and inaction.

Experience can be a harsh, though necessary, teacher. Growth will not be restored easily or quickly. Perhaps we needed the preoccupation with austerity to teach us the value of a balanced growth agenda.

Michael Spence, a Nobel laureate in economics, is Professor of Economics at New York University’s Stern School of Business and Senior Fellow at the Hoover Institution.

Copyright: Project Syndicate, 2013.

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