The European Sovereign Debt Crisis and the Debate on Deficit Spending

The European sovereign debt crisis continues to attract a lot of attention on both sides of the Atlantic. The analysts have proposed many several potential causes for this crisis and, obviously, the lack of fiscal discipline, including the issue of deficit spending, is widely considered as one of the most important ones. An analysis of this issue can shed some light on the problem of deficit spending which is highly debated in the United States in the last years.

For the proponents of deficit spending, this is best approach in terms of fiscal policy especially in times of crisis. As the Krugman wrote, “the danger for next year is not that the deficit will be too large but that it will be too small, and hence plunge America back into recession”. Moreover, in what can be considered as a summary of the pro fiscal deficit view, he also argued that deficit spending could be permanently used, as far as “all we need is a deficit small enough that debt grows more slowly than the economy”.

The reality of the Eurozone debt crisis however starkly contradicts these assertions. To start with, running deficits have not helped the European countries to alleviate the recessions. The countries most severely hit by the crisis, especially Greece and Spain, were already running budget deficits before the crisis. Not only that this did not prevent the crisis, but the fact that they continued to have budget deficits had negative effects on their economic performance during the crisis.

The economic reality of the sovereign debt crisis pretty much also puts in doubt the idea that things are alright as far as the debt grows slower than the economy. It is well-known that the European countries most affected by the debt crisis are also the ones that developed fast in recent times. For example, due to its very fast development, namely an average economic growth of over 9% along of more than a decade, Ireland came to be known as the “Celtic Tiger”. However this has not prevented that Ireland, along other fast European growing economies like Spain, Portugal or Greece, became in the end severely affected by the debt crisis.

To sum up, there are important implications of the European sovereign debt crisis for the current public debate on deficit spending. The recent debt crisis has shown us that deficit spending is ineffective in fighting a recession, especially when the recessions is very severe and it is related to sovereign debt. Moreover, a slow-growing debt does not make sure that debt problems will not emerge, since, when recessions are abrupt, the debt can rise very fast. It is time to ask whether governments should review their stance on the use of deficit spending.


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