Austerity and recovery: East Asian lessons for Europe
By Peter Henry and Anusha Chari
Comparing the divergent recoveries in Europe and East Asia also yields the conclusion that, in response to similar crises, it is not simply the size of the fiscal stimulus that matters but also its variability and persistence.
In contrast to the previous literature on fiscal adjustment, this is precisely the approach we adopt in a new paper, “Two Tales of Adjustment: East Asian Lessons for European Growth” (Chari and Henry 2015). Roughly a decade apart, East Asia and Europe were each struck by recessions caused by a similar set of factors: excessive lending (especially in real estate) leading to a high incidence of non-performing loans and failure of financial institutions, followed by a severe credit crunch. Leaders of East Asia responded with standard textbook expansionary fiscal policy, while European leaders switched from fiscal expansion to consolidation before their crisis-ridden economies had recovered.
Using a macro case study in the spirit of the policy experiment approach (see Henry 2007, Henry and Miller 2009), we exploit the similarities between the causes of the Asian financial crisis of 1997–1998 and the Global Crisis of 2008–2009 – and the differences in economic policy responses – to provide a setting in which we can more definitively answer the following question: Did the large and abrupt reversal from fiscal stimulus to fiscal consolidation in Europe at a moment when output was still falling cause its post-crisis recovery to be slower and less complete than it would have been in the absence of this policy reversal?
Read the full article as published in Vox.
Peter Henry is the Dean of the Leonard N. Stern School of Business, Dean Richard R. West Professor of Business and William R. Berkley Professor of Economics & Finance.