Euro Crisis 2013: Austerity and Stimulus Combined Can Save the EU

Three years after the February 2010 summit of finance ministers and central bankers that replaced financial rescues and stimulus with austerity, leaders from those same countries are calling for an end to austerity. With European economies contracting and the recent discrediting of the Reinhart-Rogoff Harvard study, austerity may be on its way out, but structural flaws make it hard to envision whether any credible alternatives exist for the EU.

As senior ING economist Carsten Brzeski remarked, "The misery continues. Almost all core countries bar Germany are in recession and so far nothing has helped in stopping this downward spiral.”

And even in Germany, accountable for a third of the EU's economy, the economy grew by a weaker than expected 0.1 percent. France’s falling into recession capped of the latest economic reports which but the 17-nation economy in its longest recession on record.  

These poor economic figures add to the particular scrutiny austerity has been under in the past few weeks. In the same week that a New York Times op-ed declared that “austerity — severe, immediate, indiscriminate cuts to social and health spending — is not only self-defeating, but fatal,” deep flaws were found in the Reinhart-Rogoff paper often cited by austerity proponents.

As public outrage over austerity reaches its limit, EU leaders will discuss a rate cut and shifting away from budget cuts at a summit next week in Brussels. However, that alone would not be enough to stem the effects of deep unemployment and lackluster private sector investment, both of which have also fuelled this recession.

In the Washington Post, Steven Pearlstein insisted that austerity should not, as has been suggested, be replaced by Keynesian policies: “The underlying structure of the economy and government finances are so bad that there will never be stimulus-induced recovery and full-employment, at least without another global credit bubble like we had a few years back.” Rather than abandon austerity, Pearlstein believes that what is required is structural reform in tandem with current austerity measures.

The solution will have to involve both Keynesian and austerity policies. Members of the EU need to acknowledge that the structural differences within the union, and therefore that no one policy will succeed. Instead, those countries such as Ireland, Britain, France, and to a lesser extent Spain, where economies are sound and competitive, should pursue the financing of deficits at reasonable rates.

However, in many of the southern European economies, the financial markets are not willing to offer up funds at reasonable rates, and with reason. These countries’ are suffering from their uncompetitive economies and profligate governments which, if not dealt with through austerity and structural reform, will pull Europe’s only growing economy, Germany, down.

With industry experts warning that recovery will be “excruciatingly slow,” likely not until 2015 at least, it is imperative for central bankers and finance ministers to recognize that there is no one size fits all solution for the EU’s crisis. Given the difference between the structural stability of northern and southern European economies, different approaches will have to be taken to pull Europe out of recession.