Design Failures in the Eurozone. Can they be fixed?. Paul De Grauwe London School of Economics. Eurozone ’ s design failures: in a nutshell. Dynamics of booms and busts are endemic in capitalism
Paul De Grauwe
London School of Economics
Thus during debt crisis banks accumulate liquidity provided by central bank
The more intense austerity programs coincide with increasing government debt ratios.
The underlying mechanism is well known since the days of Irvin Fisher (Fisher(1936)).
the stronger is the austerity program the deeper is the decline in GDP.
The estimated equation suggests that on average for every one percent increase in austerity output declines by 1.4%
a one percent increase in austerity on average leads to a 0.5% improvement in the budget balance.
Put differently, in order to improve the budget balance by 1% an austerity program of at least 2% is necessary
Since fiscal multiplier = 1.4 this means that the cost of 1% improvement in budget balance has a price of a loss of output of 2.8%
It is my contention that a more symmetric fiscal adjustment (creditor nations stimulate their economies)
When, however, all the countries try to save more at the same time, i.e. they all attempt to create current account surpluses, each country’s attempt to do so makes it harder for the others to achieve their objectives, forcing them to increase their austerity efforts.
Two components of fiscal union