Austerity Agonistes: Why Left Wing Economists’ Warnings against Austerity Programs are Wrong

One of the key signalling devices for international investors is how a government behaves under financial duress – how it balances the demands of its debtors with those of its welfare recipients. Announcements of lower spending and higher taxes tell investors a country is willing to go to great lengths not to default on its debt obligations. If the government instead focuses on preserving its welfare state and public employee benefits, investors know default is more likely and will shy away from that country’s bonds, says Veronique de Rugy, a senior research fellow at the Mercatus Center at George Mason University.

The notion that austerity is bad and stimulus is good rests on the Keynesian theory that if the government spends a lot of money, that money will create more value in economic growth. This purported increase in gross domestic product is what economists call the “multiplier effect.” It is a nice story, but like most fairy tales, it has scant basis in reality, says de Rugy.