[As usual lately, this is a slightly edited AI translation of a piece written for the Italian Daily Domani]

The European Commission recently revised downwards its forecasts for both growth and inflation, which continues to fall faster than expected. In contrast to the United States, there is no “soft landing” here. As argued by many, monetary tightening has not played a major role in bringing inflation under control (even as of today, price dynamics are mainly determined by energy and transportation costs). Instead, according to what the literature tells us on the subject, it is starting, 18 months after the beginning of the rate hike cycle, to bite on the cost of credit, therefore on consumption, investment and growth.

This slowdown in the economy is taking place in a different context from that of the pandemic. Back then, central bankers and finance ministers all agreed that business should be supported by any means, a fiscal “whatever it takes”. Today, the climate is very different, and public discourse is dominated by an obsession with reducing public debt, as evidenced by the recent positions taken by German Finance Minister Lindner and the disappointing reform of the Stability Pact. The risk for Europe of repeating the mistakes of the past, in particular the calamitous austerity season of 2010-2014, is therefore particularly high.

In this context, we can only look with concern at what is happening in France, where the government also announced a downward revision of the growth forecast for 2024, from 1.4% to 1%. At the same time, the Finance Minister Bruno Le Maire announced a cut in public spending of ten billion euros (about 0.4% of GDP), to maintain the previously announced deficit and debt targets. This choice is wicked for at least two reasons. The first is that it the government plans making the correction exclusively by cutting public expenditure, focusing in particular on “spending for the future”. €2 billion will be taken from the budget for the ecological transition, €1.1 billion for work and employment, €900 million for research and higher education, and so on. In short, it has been chosen, once again, not to increase taxes on the wealthier classes but to cut investment in future capital (tangible or intangible).

But regardless of the composition, the choice to pursue public finance objectives by reducing spending at a time when the economy slows, down goes against what economic theory teaches us; even more problematic, for a political class at the helm of a large economy, it goes against recent lessons from European history.

The ratio of public debt to GDP is usually taken an indicator (actually, a very imperfect one, but we can overlook this here) of the sustainability of public finances. When the denominator of the ration, GDP, falls or grows less than expected, it would seem at first glance logical to bring the ratio back to the desired value by reducing the debt that is in the numerator, i.e. by raising taxes or reducing government spending. But things are not so simple, because in fact the two variables, GDP and debt, are linked to each other. The reduction of government expenditure or the increase of taxes, and the ensuing reduction of the disposable income for households and businesses, will negatively affect aggregate demand for goods and services and therefore growth. Let’s leave aside here a rather outlandish theory, which nevertheless periodically re-emerges, according to which austerity could be “expansionary” if the reduction in public spending triggers the expectation of future reductions in the tax burden, thus pushing up private consumption and investment. The data do not support this fairy tale: guess what? Austerity turns out to be contractionary!

In short, a decline in the nominator, the debt, brings with it a decline in the denominator, GDP. Whether the ratio between the two decreases or increases, therefore, ends up depending on how much the former influences the latter, what economists call the multiplier. If austerity has a limited impact on growth, then debt reduction will be greater than GDP reduction and the ratio will shrink: albeit at the price of an economic slowdown, austerity can bring public finances back under control. The recovery plans imposed by the troika on the Eurozone countries in the early 2010s were based on this assumption and all international institutions projected a limited impact of austerity on growth. History has shown that this assumption was wrong and that the multiplier is very high, especially during a recession. A  public mea culpa from  the International Monetary Fund caused a sensation at the time (economists are not known for admitting mistakes!), explaining how a correct calculation gave multipliers up to four times higher than previously believed. In the name of discipline, fiscal policy in those years was pro-cyclical, holding back the economy when it should have pushed it forward. The many assistance packages conditioning the troika support to fiscal consolidation did not secure public finances; on the contrary, by plunging those countries into recession, they made them more fragile. Not only was austerity not expansive, but it was self-defeating. It is no coincidence that, in those years, speculative attacks against countries that adopted austerity multiplied and that, had it not been for the intervention of the ECB, with Draghi’s whatever it takes in 2012, Italy and Spain would have had to default and the euro would probably not have survived.

Since then, empirical work has multiplied, with very interesting results. For example, multipliers are higher for public investment (especially for green investment) and social expenditure has an important impact on long-term growth. And these are precisely the items of expenditure most cut by the French government in reaction to deteriorating economic conditions.

While President Roosevelt in 1937 prematurely sought to reduce the government deficit by plunging the American economy into recession, John Maynard Keynes famously stated that “the boom, not the recession, is the right time for austerity.” The eurozone crisis was a colossal and very painful (Greece has not yet recovered to 2008 GDP levels), a natural experiment that proved Keynes right.

Bruno Le Maire and the many standard-bearers of fiscal discipline can perhaps be forgiven for their ignorance of the academic literature on multipliers in good and bad times. Perhaps they can also be forgiven for their lack of knowledge of economic history and of the debates that inflamed the twentieth century. But the compulsion to repeat mistakes that only ten years ago triggered a financial crisis, and threatened to derail the single currency, is unforgivable even for a political class without culture and without memory.