Wednesday, July 23, 2014

Andrea Terzi — Europe Must Escape A Savings Trap, Not A Liquidity Trap

A better explanation for the prolonged stagnation in Europe puts at the center of the problem European fiscal policy aimed at reducing public debt. Although there is a growing literature on this, it is not immediately obvious why cutting public debt should harm growth and jobs. In the 1980s, when fiscal retrenchment became popular as a tool to reduce public borrowing, Josef Steindl explained the situation brilliantly. This, in a nutshell, is Steindl’s argument applied to the Eurozone: 
1) In every monetary economy there is a demand for savings.
2) For every euro saved, there must be a euro of debt in the system.
3) When some are attempting to increase their savings while others are attempting to deleverage and reduce debt, an inevitable inconsistency develops that drives the economy into a recession.
4) The public purpose of government policy should be that of providing the economy with sufficient funding to make the volume of debt coherent with the demand for savings.
5) This policy tool does not yet exist in the Eurozone.
 
There was no inconsistency in Europe between savings and debt until 2006, as long as the desired savings of some matched the desired indebtedness of others. When private debt became unsustainable, however, an accounting counterpart of Europeans’ savings evaporated, domestic demand collapsed, and unemployment rose sharply. Initially (2008-2009), public debt automatically took the place of private debt. But, when government deficits exceeded official ceilings and full austerity began, a rising demand for savings and a falling demand for private and public indebtedness were forced to collide. 
When people feel they cannot save enough while at the same time private and public debt is being cut, a recession and its consequent huge waste of human and material resources simply cannot be avoided.
Social Europe Journal
Europe Must Escape A Savings Trap, Not A Liquidity Trap
Andrea Terzi | Professor of Economics at Franklin College, Lugano, Switzerland

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