A Natural Experiment About Fiscal Austerity

by: Lok Sang Ho

America and Europe started from similar conditions at the height of the global financial tsunami. Their fiscal conditions in terms of debt to GDP or deficit ratio are roughly similar. But they went on different paths. America saw its federal government outlays expand rapidly in 2009, then shrank slightly in 2010, and then continued to expand at a much moderated pace. Without severe austerity, and with the help of monetary stimulus, receipts kept growing, and the deficit kept shrinking. The deficit to GDP ratio was only slightly above 7% last year and is due to decline to roughly 5.3% of the GDP this year. The economy kept growing. Not a quarter passed with negative growth. Unemployment kept declining. The following data comes from the U.S. President's Report in 2012:

Click to enlarge

Actually the data herein overstated the deficit in 2012, which was only 1089 billion or 7% of the GDP according to the Congressional Budget Office.

Europe kept demanding members of the eurozone to adopt austerity measures. The UK is not in the eurozone, but went austere in its own way. All of the countries, from the UK to Spain to France to Greece, saw their economies struggling, and notwithstanding large haircuts for Greek debt, recovery is not in sight, even healthy fiscal conditions are not in sight. The main reason why stock prices in recent months rebounded is continued growth in America and in Asia in general, plus further the promise of further monetary easing in Europe.

The different fiscal stances adopted in Europe and in America provide what economists call a "natural experiment"--whereby two alternative policies are tried in the real world, as opposed to a laboratory, and whereby their respective results testify to their success or folly. While American housing prices are rebounding, further lending support to the recovery, Europe is still bleeding, to the extent that even democracy itself has been called into doubt.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.