Spending cuts beat tax hikes only when central banks can still cut interest rates

Evidence

Furthermore, and especially relevant to the situation of the Eurozone and the United States today, they find that while it is true that cuts in spending contract the economy less than tax increases, this occurs not because of expectations but because of the ability of the central bank to offset the contraction with an interest-rate cut. Given that interest rates are at or are near zero, no such effect will be forthcoming at the moment—there is only hurt to look forward to from such policies. Finally, even a devaluation, which is always an important component of expansionary adjustments, will not suffice to promote growth. “Because not all countries can increase net exports at the same time, this finding implies that fiscal contraction is likely to be more painful when many countries adjust at the same time.” — Mark Blyth, Austerity, 578

Categorization

• XREF: The ‘many countries adjusting at once’ point connects directly to Mattei’s argument about the international coordination problem of austerity.