Despite the large economic losses in the Eurozone since 2008 one will hear the same constant argument: Most countries (especially those in the periphery) lived ‘beyond their means’ and the correction that followed was inevitable. Austerity might cause short-term pain but the subsequent economic recovery (however weak and thin) vindicates its use and merits.
In this short post I will take a rather simplistic approach. Since the ECB inflation target is 2% while the usual assumption about long-run growth in per capita real output is also 2% we can compare the path of NGDP per capita in European countries to a 4% trend:
What we see is quite significant. It is true that before 2008 Greece and Spain had a NGDP path that constantly diverged from the 4% long-run trend (this pattern is especially strong in the Greek case). France, Italy and Portugal roughly followed the long-run trend while Germany quickly suffered significant losses due to its stagnant domestic demand environment and low inflation.
What is especially interesting is the path of NGDP/capita since the Great Recession. All countries seem to have suffered significant and permanent losses with their expected expansion path moving to a new and lower level. This is even more visible in the case of Greece and Italy where their projected 2016 NGDP per capita level will only be 70% of the long-term trend. Interestingly, Spain seems to be the country that has suffered the least losses compared to the trend line while France, Germany and Portugal are quite far from the 4% growth path (France at 74% while Germany and Portugal are close to 78%) with France actually growing only by 1.5% since 2012.
Yes, the path of Greece and Spain up to 2008 seems to have been unsustainable (in the context of a monetary union). Yet their correction entailed significant and permanent losses while the whole of the Eurozone is now on a new growth path at least 20-25% lower than the long-term 4% trend. Austerity and tight monetary conditions result in large output losses that are lost forever. Adding a few years of income 20-25% lower than trend implies a permanent loss of more than a year’s worth of income which in the context of a person’s lifespan is more than important.