Economics, 3rd Edition

The Argument for Growth 

The main cause of the problems facing Europe stem from the financial system 

not from government debt. Austerity at a time of economic slowdown will affect economies considerably 

and will be further exacerbated by the lack of credit in economies caused by banks seeking to recapitalize 

and rebuild their balance sheets. Without an adequate supply of credit, consumer spending and business 

investment will decline and lead to a prolonged and damaging period of economic depression. If output 

declines, tax revenues will fall and government spending on benefits will rise and far from alleviating the 

debt crisis will merely mean governments are forced to borrow more. The only way to solve the debt 

crisis is to get economies growing again. Governments need to adopt Keynesian style stimulus spending; 

stronger economic growth will lead to increased tax revenues and if unemployment falls, government 

spending on welfare support drops reducing the need to borrow.

A Resolution?

At the time of writing the outcome of the debate over austerity and growth is far from resolved and indeed 

it is probably unfair to suggest that the argument is a simple split between those pushing to maintain aus-

terity at all costs and those who want to abandon austerity and go for growth. The EU Commission issued 

a statement in the Spring of 2013 refuting suggestions that austerity policies lacked flexibility and that the 

necessity for growth was being ignored.

The Commission argues that the extent of the spreads on sovereign debt did indicate that there were 

legitimate concerns over the threat of default by some countries but acknowledge that there were also 

some speculative reasons for the extent of the spreads. It also points to the policy adopted by the ECB 

of outright monetary transactions (OMT) where the ECB buys the bonds of Europe’s indebted countries 

to help push up the price and lower yields. This will not only help reduce the cost of servicing the debt 

but also signals to the markets that the euro will be protected. To make such a policy credible, structural 

reforms and fiscal consolidation is necessary. Structural reforms, such as improving the flexibility of labour 

and product markets will help to reduce wage and price rigidities, will take time to yield benefits but are 

essential if Europe is to be competitive in a global economy. The lowering of yields and spreads on sover-

eign debt in the latter part of 2012 and into 2013 was testament, it argued, that the policy was starting to 

have some impact.

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