Why doesn't Europe have a theory?

For completeness sake, I should probably explain the one area where I disagree with Paul Krugman about "that austerity nonsense", as I called it yesterday.

Krugman constantly describes the actions of the European leaders in the current economic crisis in terms of "the confidence fairy". I, on the other hand, think that this is wrong.

To be sure, when Wolfgang Schäuble came here to Florence last week to participate in Debating Europe, he spent a minute making the argument that research has shown that there is a debt/GDP ratio above which countries cannot tread without getting into difficulties. (Never mind that this research, by Reinhart and Rogoff, is highly flawed. It also conveniently ignores such pertinent cases as the 250% Debt/GDP ratio enjoyed by the UK at the start of its post-war economic boom.) However, the vast majority of policy makers either do not mention such research at all, or - like Schäuble - mention it only to "sell" something they already want to do anyway. That's why it is pointless to follow the Krugman mantra and keep taking pot-shots at the confidence fairy. The confidence fairy doesn't matter, it is only a rationalisation.

And that's what really puzzles me. For all its flaws, expansionary austerity is an actual theory. A wrong theory, but a theory that could conceivably be correct. It is possible to imagine a parallel universe where this would be a coherent description of what happens, where this theory would result in correct and useful policy prescriptions. It's not this one, but it's close. Actual this-world economic science has some better models too, generally rooted in Keynesianism. They tell you that the consequences of a fiscal impulse in the economy (i.e. the opposite of austerity) generally depend on the reaction of the central bank and more generally on the scope for crowding out on capital markets. Given that we're currently about 100 miles away from any rate increase, that no one is borrowing, that there are no inflation worries, no nothing, it's the best of all possible situations for stimulus. There's no down side, as long as you spend it on something that's worth the (near-zero) interest you have to pay to borrow the money in question. That's another model.

So if European policy makers aren't working from a framework of expansionary austerity, and they're not doing any form of Keynesianism, what are they doing? What is their model of the economy, the model that they are using to decide when to apply how much austerity?

The answer is that I think they don't have one. For people like Angela Merkel austerity is not something they do because they think it will benefit the German or European economy. Instead I think they view it purely in moral terms: the government should pay its own way the same as everybody else. To do differently would be unethical. In Germany, this is known as the principle of the Swabian Houswife. This is very, very bad.

If the German/Dutch approach were based on some kind of economic theory, it would be possible to have a reasoned argument about its efficacy. But given that their preference is purely value-based, it is like a religion. De religionis non est disputandum. But if we're not careful, this religion is going reduce us all to poverty.