No Pain, No Gain: Without fiscal stability, there will be no economic growth
The economic rationale of the current crisis is remarkably simple: Without fiscal stability, there will be no economic growth.
On March 2nd 2012, European policymakers signed a new fiscal compact in record speed. Its main pillar consists of the implementation of domestic debt rules, which should ideally be on a constitutional level, similar to the debt brake instituted by Germany in 2010. But after the election weekend in France and Greece, left-wing and radical parties voiced opposition towards this policy: Hollande in France demands a growth pact in addition to the fiscal compact, while Greece’s left parties want to remove the austerity measures completely. A fair question is raised: Are the economic impacts of stability and growth programs contrary to each other, or do they constitute interrelated necessities?
Establishing economic growth is obviously a long-term project. Growth theory suggests investments in education, research and development, and infrastructure to be the most promising in order to sustain future economic growth. Short-term stimulus packages, however, are not effective in the long-run and just a flash in the pan. These packages won’t generate any growth, but at best promise a short rebound for one or two years. Even if we would have supposed such a stimulus to be slightly helpful, recent economic research disproved it. Reinhard and Rogoff, two well-known macroeconomists from Harvard University, show that in case of a debt-to-GDP ratio above 80%, growth will decline.
Applying this finding to the situation in Europe is quite easy: In a crisis of confidence, which was created by excessively high debt levels, growth packages financed via deficit or higher taxes will have no effect either in the short-, medium-, or long-term.