Austerity fails policy test

By Henry CK Liu

There is an undisputed general law in public finance that sound fiscal policies must precede a sound currency. What is in dispute is what constitutes a sound fiscal policy. Neo-liberals deem recurring fiscal deficits as signs of unsound fiscal policy. Yet over the multi-year duration of most recession phases of business cycles in market economies, multi-year deficit financing to stimulate economic activities in a recession can be a very sound fiscal policy.

Under such circumstances, a balanced annual budget would be quite the opposite of a sound fiscal policy. Still, some recessions may take more than a decade to recover, even with persistent fiscal deficits if the funds are spent on wrong targets, as in the case of Japan after the Plaza Accord of 1985.