The intellectual justification for austerity lies in ruins. It turns out that Harvard economists Carmen Reinhart and Ken Rogoff, who originally framed the argument that too high a “debt-to-GDP ratio” will always, necessarily, lead to economic contraction, had based their entire argument on a spreadsheet error. There is now no definite proof that high levels of debt necessarily lead to recession.
Will we, then, see a reversal of policy? A sea of mea culpas from politicians who have spent the last few years telling disabled pensioners to give up their bus passes and poor students to forgo college? It seems unlikely. After all, austerity was never really an economic policy: Ultimately, it was always about morality — a politics of crime and punishment, sin and atonement.
True, it is never been particularly clear what the original sin was: some combination, perhaps, of tax avoidance, laziness, benefit fraud and the election of irresponsible leaders. However, in a larger sense, we were guilty of having dreamed of social security, humane working conditions, pensions, and social and economic democracy.
The morality of debt has proved spectacularly good politics. It appears to work just as well whatever form it takes: fiscal sadism (Dutch and German voters really do believe that Greek, Spanish and Irish citizens are, as they put it, “debt sinners,” and support politicians willing to punish them) or fiscal masochism (middle-class Britons really will dutifully vote for candidates who tell them that they must tighten their belts).
If ever proof was required that the theory is selected to suit the politics, one need only consider the reaction politicians have to economists who dare suggest this moralistic framework is unnecessary. Even before we knew Reinhart and Rogoff’s study was wrong, many had pointed out that their historical survey made no distinction between the effects of debt on countries such as the US or Japan — which issue their own currency and therefore have their debt denominated in that currency — and countries such as Ireland and Greece, that do not. However, the real solution to the eurobond crisis lies in precisely this distinction.
Why is Japan not in the same situation as Spain or Italy? It has one of the highest public debt-to-GDP ratios in the world (twice that of Ireland) and is regularly featured in magazines like the Economist as a prima facie example of how not to manage a modern economy. Yet they have no problem raising money. In fact, the rate on their 10-year bonds is under 1 percent. Why? Because there is no danger of default. Everyone knows that in an emergency, the Japanese government could simply print the money.
This is precisely what Ireland, or Spain, or any of the other troubled southern eurozone countries, cannot do. Since only the German-dominated European Central Bank can print euros, investors in Irish bonds fear default, and the interest rates are bid up accordingly.
Hence the vicious cycle of austerity. As a larger percentage of government spending has to be redirected to paying rising interest rates, budgets are slashed, workers fired, the economy shrinks and so does the tax base, further reducing government revenues and further increasing the danger of default. Finally, political representatives of the creditors are forced to offer “rescue packages,” announcing that, if the offending country is willing to chastise its sick and elderly, and shatter the dreams and aspirations of a sufficient percentage of its youth, they will take measures to ensure the bonds will not default.