27 May 2010

Oh My Gawd, They Killed Recovery!

Not yet, perhaps but 2010 is beginning to look like 1937.

In 1937, Roosevelt cut government spending in the belief that the Great Depression was over. The result was a new recession and the Depression went on.

This week, Italy has announced cuts of €24 billion targeting pensions, public sector wages and recruitment. Spain is cutting €15 billion with public sector pay again in the firing line. Portugal announced its austerity measures back in March. Even Germany is preparing cuts - apparently to set an example for the others.

One difference between Europe today and the US in 1937 is that the Fed tightened monetary policy while European interest rates are unchanged. That is a little deceptive since interest rates are at their lower bound. It is difficult to loosen monetary policy when interest rates are almost at zero, otherwise monetary policy would be looser.

Back in January, Paul Krugman was warning of the danger that the US might replay 1937.

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