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Fiscal Traps and Macro Policy after the Eurozone Crisis

  • Greg Hannsgen
  • Dimitri B. Papadimitriou

The United States must make a fundamental choice in its economic policy in the next few months, a choice that will shape the US economy for years to come. Pundits and policymakers are divided over how to address what is widely referred to as the "fiscal cliff," a combination of tax increases and spending cuts that will further weaken the domestic economy. Will the United States continue its current, misguided, policy of implementing European-style austerity measures, and the economic contraction that is the inevitable consequence of such policies? Or will it turn aside from the fiscal cliff, using a combination of its sovereign currency system and Keynesian fiscal policy to strengthen aggregate demand? Our analysis presents a model of what we call the "fiscal trap"—a self-imposed spiral of economic contraction resulting from a fundamental misunderstanding of the role and function of fiscal policy in times of economic weakness. Within this framework, we begin our analysis with the disastrous results of austerity policies in the European Union (EU) and the UK. Our account of these policies and their results is meant as a cautionary tale for the United States, not as a model.

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Paper provided by Levy Economics Institute in its series Economics Public Policy Brief Archive with number ppb_127.

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Date of creation: Oct 2012
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Handle: RePEc:lev:levppb:ppb_127
Contact details of provider: Web page: http://www.levyinstitute.org

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  1. Greg Hannsgen, 2007. "A Random Walk Down Maple Lane? A Critique of Neoclassical Consumption Theory with Reference to Housing Wealth," Review of Political Economy, Taylor & Francis Journals, vol. 19(1), pages 1-20.
  2. Galbraith, James K., 2012. "Inequality and Instability: A Study of the World Economy Just Before the Great Crisis," OUP Catalogue, Oxford University Press, number 9780199855650, March.
  3. Nina Budina & Andrea Schaechter & Anke Weber & Tidiane Kinda, 2012. "Fiscal Rules in Response to the Crisis; Toward the "Next-Generation" Rules: A New Dataset," IMF Working Papers 12/187, International Monetary Fund.
  4. Till van Treeck, 2012. "Did inequality cause the U.S. financial crisis?," IMK Working Paper 91-2012, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
  5. Engelbert Stockhammer & �zlem Onaran & Stefan Ederer, 2009. "Functional income distribution and aggregate demand in the Euro area," Cambridge Journal of Economics, Oxford University Press, vol. 33(1), pages 139-159, January.
  6. Rania Antonopoulos & Kijong Kim & Thomas Masterson & Ajit Zacharias, 2011. "Investing in Social Care Delivery," Economics One-Pager Archive op_11, Levy Economics Institute.
  7. Dimitri B. Papadimitriou & Greg Hannsgen & Gennaro Zezza, 2012. "Back to Business as Usual? Or a Fiscal Boost?," Economics Strategic Analysis Archive sa_apr_12, Levy Economics Institute.
  8. L. Randall Wray, 1998. "Modern Money," Macroeconomics 9810002, EconWPA.
  9. Dimitri B. Papadimitriou & L. Randall Wray, 2012. "Euroland's Original Sin," Economics Policy Note Archive 12-08, Levy Economics Institute.
  10. Jan Kregel, 2012. "Six Lessons from the Euro Crisis," Economics Policy Note Archive 12-10, Levy Economics Institute.
  11. Engelbert Stockhammer & Eckhard Hein & Lucas Grafl, 2011. "Globalization and the effects of changes in functional income distribution on aggregate demand in Germany," International Review of Applied Economics, Taylor & Francis Journals, vol. 25(1), pages 1-23.
  12. Tagkalakis, Athanasios, 2013. "The effects of financial crisis on fiscal positions," European Journal of Political Economy, Elsevier, vol. 29(C), pages 197-213.
  13. Dimitri B. Papadimitriou, 2008. "Promoting Equality Through an Employment of Last Resort Policy," Economics Working Paper Archive wp_545, Levy Economics Institute.
  14. Wynne Godley & Marc Lavoie, 2007. "A simple model of three economies with two currencies: the eurozone and the USA," Cambridge Journal of Economics, Oxford University Press, vol. 31(1), pages 1-23, January.
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