We are again in a pre-Keynesian world, when the cure of a depression consisted in cutting expenditures and rising taxes.
During the fifties and the sixties students of economics read the Keynesian model on macroeconomics textbooks like those of Alvin Hansen and Richard Musgrave, and were amused discovering that there was no particular virtue in a balanced budget. Taxes and public expenditures have to be used in order to stabilize the economy, and, according to necessities, fiscal policy should be expansive or restrictive. Moreover rising public services and financing with taxes does have a positive effect on the Gdp (the famous Haavelmo’s theorem).
The seventies brought several critics to the Keynesian model, in part with some justifications, but very few people could, at that time, foresee that the principle of a balanced budget would achieve a constitutional status among several European countries; not to say that again the theme is on the US political agenda.
Just few days ago the Italian House of Representatives (Camera dei Deputati) approved the principle of balanced budget, almost unanimous, as a constitutional law. So Italy, like Spain and France, are obeying to the German ultimatum; Germany did the same just two years ago.
So we are again in a pre-Keynesian world, when the cure of a depression consisted in cutting expenditures and rising taxes. Now an aspect of the Keynesian approach, which is behind any criticism, is that of the built-in stabilizers: when there is a slow down, taxes decrease and expenditures (unemployment benefits) increase. In this way there is a reduction of the slow down, and when the recession is over, taxes increase and benefits decrease.
The balanced budget introduces a built-in de-stabilizer: When the economy goes down taxes must be raised and expenditures reduced; the opposite when the economy is going well. Many Italian economists (and also some German) recently wrote a letter to the Parliament and political leaders arguing in favour of a support of the aggregate demand and against the policy of alancing the budget (A Statement by Italian and foreign Economists on the Crisis in Italy and the Eurozone [2])). A similar letter was send recently to President Obama by important US economists.
The balanced budget derives from an ideological approach according which perturbations to the economy could rise only by the public sector. It is unfortunate that Karamanlis government disguised the true public deficit in Greece starting the avalanche that, thanks to BCE and Merkozy, threatens to run over euro. This fact disguised the real origin of the crisis, due to the craziness of the private – mainly financial – sector. We should remember that in 2007 Ireland and Spain had a debt-Gdp ratio much lower than many other countries (respectively 24,8% and 36,2%), and even Italy had 103,1% (while in 1994 the ratio was 124,9%).
The macroeconomic experiment brought about by European governments will demonstrate that the story of the expansionary restrictions on public deficit doesn’t work. Unfortunately Europe, but not only Europe, will pay a high price for this craziness.