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Tuesday 22 Aug 2017 | 00:45 | SYDNEY
Tuesday 22 Aug 2017 | 00:45 | SYDNEY

Too early to cut government spending?

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16 February 2011 17:13

The Economist's Free Exchange blog sees very dark clouds on the European horizon. The big euro economies are slowing, yet the 'tide of austerity across the continent' has left European economies in a tough policy bind. 'What was needed, amid big fiscal cuts, was a very accommodative monetary policy', says Free Exchange. But for various reasons, that now looks unlikely.

I have already urged readers to check out economist Richard Koo's presentation to the Lowy Institute last Wednesday, and this gives me another chance to do it. Koo's argument, drawing on the Japanese experience, is that 'accommodative monetary policy' cannot compensate for government austerity. Japan tried twice during its 'lost decade' to cut government spending, but although interest rates were near zero, the private sector did not take up the slack. Here's the table he used to illustrate his point:

Koo's argument was that it is too early for austerity because the private and household sectors are busy paying down debt and in no mood to borrow, no matter how low interest rates go. According to Koo, this is not (yet) the time to worry about deficits. Monetary policy won't fix this problem; only government spending can.

As you can probably tell, I found Koo's presentation compelling. I would love to hear why he might be wrong.

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