Anorak News | Why the Euro bailout just won’t work

Why the Euro bailout just won’t work

by | 5th, October 2012

AMBROSE Evans Pritchard over at the Telegraph has a great little piece about why the basic method being used in the eurozone bailout just won’t work. It’s here and is probably really for geeks and wonks. But to simplify the argument…..

OK, so if you try to cut government spending in order to close the deficit then there’s going to be some shrinkage of the economy. Partly because Keynes said so, partly because of the way that we calculate GDP itself (government spending is a part of GDP so if we shrink it then GDP shrinks). The big question is well, how much? If cutting government spending by 1% cuts GDP by 0.5% then it all might be very painful but it will work in the end. You’ll be able to close that deficit.

However, if cutting by 1% shrinks the economy by 2% then you’ll never get there. You’ll end up destroying more in tax revenue through the smaller economy than you’ve saved by not spending it. And what are the actual numbers?

Well, for the countries in the Euro it looks like it’s more than one for one. A 1% cut in govt. spending causes a more than 1% shrivelling of the economy. So you can’t do it, you just cannot get there.

What’s more fun is that if you’ve got your own currency (meaning you can devalue it at the same time as cutting) then a 1% cut leads to a smaller than 1% shrinkage. This doesn’t mean that Osborne is going to get it right of course, but it does leave open the theoretical possibility that he might. But if you’re in the euro then it definitely won’t work.

Which is something of a problem. For the reason they’re all doing this cutting is to save the euro. But their saving the euro is the very reason that the cutting won’t work.

Bit of a problem that really.


Posted: 5th, October 2012 | In: Money Comment | TrackBack | Permalink