The Journey of Austerity in Europe

Written By: Xue Han
Luxembourg Garden Fellow, Global Infrastructure Asset Management LLC

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Quick Note

Following on Xue Han’s paper that estimated impact of the “multiplier effect” on the U.S. economy of the automatic budget cuts that the U.S. Congress has imposed (Deficit Reductions and Multiplier Effects on the U.S. Economy, January 2012), I asked her to estimate the impact of the austerity programs that several members of the European Community have agreed to implement in order to confirm their commitments to remain members of the EC.  In The Journey of Austerity in Europe, she provides her forecasts for economic growth in each of the countries that make up the bulk of the EC.  In this paper, Xue Han describes and compares the austerity measures of each subject country and applies an estimate of the multiplier to the available forecasts of GDP.  Her research demonstrates that policy decisions to “front load” or “back load” budget cuts or tax increases are critical in determining the paths of economies in the region and provides estimates for the recoveries of these economies.

William M. Fitzgerald

Executive Summary

The task of this research paper is to present factual details of the austerity packages adopted by multiple EU countries and provide theoretical analysis of the controversial outcomes they will bring. This report has six major sections and is structured as follows. Section 1 briefly describes the economic and political situations of the ongoing debt crisis within the EU countries and the external support they received from the International Monetary Fund (IMF) with conditionalities. The second section, after formally defining austerity package and introducing its typical measures and fundamental goals, paints a big picture of the size and timing of the packages for all those countries on which we have information; also included, are detailed demonstrations of the austerity stories of ten countries, namely Germany, France, Italy, Spain, Austria, Greece, Latvia, Portugal and Ireland. These countries are considered as having significant impacts on the overall economy in the EU area and have implemented or planned for austerity programs. This section also provides a map on the composition of each country’s austerity measures, divided between spending cuts and tax hikes.  The results are described in the table below.

Based on certain assumptions, our estimates show that by 2016, austerity programs in these nine countries studied will negatively affect the regional economy to downsize by 3.13%, or 278.7 billion euros in total, compared to the scenario without austerity measures. In a simple average term, that is an average 4.29% lower nominal GDP than originally projection for each country. Yet fortunately, the harm of austerity does not linger long over their economic growth rates to be observed in 2016. On the budgetary side, pictures will become harsher with a total of 160.6 billion euros, or 1.87% increase in government budget deficit in these nine countries by 2016, when most countries are targeting at balanced budgets; in a simple average term, each country will see a budget deficit that is 2.2% higher than what they currently plan for.

With the nine EU countries that are considered crucial to the future directions of EU and the single currency studied, these detailed quantitative medium-term projections could provide precious insights for investors and policy makers worldwide on the complicated situation of the European debt crisis and its austerity progress.