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European Fiscal Policy: The wrong recipe for growth

How does Europe address economic crises? Swept by the “austerian” movement of the 2010’s[1], fiscal policy for crisis management in the EU demands sacrifice. Gripped by austerity fever, E.U. politicians created fiscal frameworks that offered loans to member nations conditional to draconian tightening. In other words, under the guise of financial assistance, the European Union acts like a private financial institution using austerity as its stick and promise of solvency as its carrot, making a buck in the process. The European Financial Stabilization Mechanism (EFSM) is one such institution meant to “preserve financial stability”[2] – a half-measure designed to preserve the status quo of a two-tier Europe; a policy proven to divide rather than unite.

Today Europe is faced with the aftermath of a pandemic, soaring inflation and an energy crisis to boot. Its response? A new-age stimulus package (a step in the right direction but fiscally insufficient), a defunct price cap policy on natural gas and a German chancellor going rogue. If the European Union does not begin to pivot towards policy that promotes solidarity then it will never realize its own vision of a socio-political union. This short paper attempts to illustrate that European monetary policy, inspired by austerity and rationalism, does not lead to desired growth but socio-political turmoil and Euroscepticism. A shift toward Keynesian monetary policy like the common issuance of debt (Eurobonds) would promote growth, internal cohesion and entail a step in the right direction.

Since its inception, the EMU relied only on fiscal rules such as the Stability & Growth Pact for basic crisis prevention through monetary prudence. In fact, there was no legal framework for managing sovereign debt crises, as any interpretation of Article 125 of the treaty on the Functioning of the European Union, referred to as the ‘no bail-out clause’, wouldn’t allow for it[3]. By the time crisis knocked on Brussels’ door, it became clear that conventional policy which deployed sound macroeconomic policy through interest cutting, wouldn’t suffice. Interestingly enough, instead of following the textbook rule to addressing recessions, which first year economics teaches us is fiscal expansion (increase spending and lower taxes), the E.U. decided to go in the complete opposite direction. Fiscal contraction they purported, was the policy to rule them all.

In 2009 the E.U., poisoned by austerio-mania, hastily produced the EFSM outside E.U. law as an intergovernmental body, in reaction to Europe’s incomplete economic governance (Bank of Italy, 2019). This grand idea would essentially reshape macroeconomic policy for the European Union by effectively instituting a fiscal framework for sovereign debt crisis management. Its only flaw, the rigorous austerity and unrealistic conditionalities blatantly inconsistent with basic macroeconomic theory. Unfortunately, during the onset of the crisis conservative elitist opinion took over, focusing only on spending cuts instead of unemployment, slashing deficits instead of increasing them - as per rudimentary monetary policy. This was due partly on account of weak political will. Politicians at the time were catering to public opinion that tends to perceive government budgets as family finances[4]. At the time, any suggestion of increased spending was not welcome. Even the Labour party was convinced, dedicating its 2015 election manifesto to a “Budget Responsibility Lock” which pledged to “cut the deficit every year” (Stewart, 2015).

One country in particular can attest to this problematic application of austerity during times of uncertainty. Drawing on the case study of the Greek financial crisis of 2009, the question becomes simple: did austerity actually work? Proponents of the EFSM’s harsh conditionalities argued that high levels of spending cuts would produce “non-Keynesian expansionary effects” and that austerity would prove beneficial in tandem with rapidly growing levels of debt-GDP (Jackson, 2011). The philosophy was simple – cut your budget, hike taxes, boost revenue and investments will rain in. As Blyth eloquently purports, “So, not only should we cut, we should cut when it hurts, in the slump, not the boom, and we should cut decisively’ (Blyth, 2013). But as was the experience in Greece, we cannot only cut and expect to grow. Many would agree – austerity for Greece did not work. John Maynard Keynes surely concurs in his 1937 writings: “The boom, not the slump, is the right time for austerity at the Treasury” (Keynes, 1937/1983).

Creditors themselves soon realized the folly of their ways. As early on as October 2012 Chief IMF economist Olivier Blanchard made a striking admission that the combination of tax hikes and spending cuts – the stick to solvency’s carrot - “have been causing far more economic damage than experts assumed” (Plumer, 2012 ). Add to that, Nobel Laureate Paul Krugman argued, “All economic research that allegedly supported the austerity push has been discredited. Widely touted statistical results were, it turned out, based on highly dubious assumptions and procedures – plus a few outright mistakes – and evaporated under closer scrutiny”[5]. Moreover, many empirical studies have attempted to better understand the relationship between austerity and growth during a recession, categorically finding that fiscal prudence undermines rather than bolsters it (Blyth, 2013). Keynes would rejoice as the case for Greece proves that “austerity does not work” (Streeck, 2013). Finally, Paul Thomsen himself, Director of the European Department of the IMF, in a 2019 speech addressed the Hellenic Republic with bleak projections, estimating that it will be another “15 years, until 2034, to return to pre-crisis levels” (Thomsen, 2019). That gives Greece a world record, breaking 25 years in recession.

Since the onset of the crisis the country witnessed impoverishment (United Nations Human Rights Office of the High Commisioner, 2013), its economy shrunk by over a quarter, wages fell sharply and confidence in the country depleted. Today after 12 years of austerity, three bailouts and 6 governments, debt to GDP remains at 182%, unemployment lingers around 17%, purchasing power has declined 67% and still some socio-economic consequences remain immeasurable (Stournaras, 2019). The data make things clear, the rate of GDP growth is negatively correlated with austerity, that is, the more austere the measures during a crisis, the slower the return to growth. This is the case especially for countries that cannot control monetary policy, make decisions on printing money or decrease interest rates - in other words those in a common currency market.

Papageorgiou et. al. argue that “in periods of crisis there is a tendency to greater merging of morality with utility maximization theory” (2021). In other words, classical rationality notions like “Homo Economicus” become prominent paradigms in fiscal policy whenever the goings get tough. Similarly, neoliberalism as an elite-driven and capital-centric mantra disguised as pragmatism can be found in fine print of E.U. policy. As such, decision making in the E.U. has always encapsulated this philosophy; the idea of market efficiency and utilitarianism as a means for achieving growth. Alas, the Maastricht Treaty denotes that candidate nations must decrease inflation, maintain price stability and have “sound public finances, to ensure they are sustainable” in order to join the Eurozone (European Commission, 2022).

The problem with mechanisms such as the EFSM is that they follow this misguided economic dogma, which is designed in accordance with rationality, that is, it follows some fundamental axioms based on utility maximization, not taking into account cultural context and the human psyche. This can be seen in the persistence of austerity over the years which sustains the status quo for those nations that remain solvent and have access to markets and those that do not. More importantly, in the tenacity of “the frugal four” in not accepting alternatives to austerity, like the common issuance of bonds in the name of “responsibility” (Kurz, 2020).

This brings us to some qualitative truths. If austerity has been unsuccessful, what is left? In the wake of the crisis, austerity left behind it political and social turmoil. The rise of the far-right Golden Dawn faction is a direct consequence of such policies. Aptly put, policies singing the tune of austerity have shown to create rifts between indebted countries and wealth abundant ones because they are divisionary by nature – they alienate the poorer and reinforce the richer. This, in turn, establishes national identity politics and lays the groundwork for sovereign protectionism within the European Union. One cannot argue that Euroscepticism is going away, that is, if Giorgia Meloni or Victor Orban have anything to say about it. Yet some change is brewing behind the bureaucratic confines of the Europa building and Europe it seems, is heading into a new chapter of its short life.

There is however a glimmer of hope even at the dawn of a new recession found in an unlikely policy - the Next Generation recovery fund. The fund is a supplementary loan/grant program, a portion of a larger long-term 2021-2027 stimulus package worth about 2 trillion euros in total (European Commission, Directorate-General for Budget, 2021). The main pillars of the package tackle climate change, poverty, technology, and structural reforms via a trusty old paradigm – collective borrowing (Franziska Brantner, 2021). In a historic move, the European Union has shown that it is capable of considering alternative policy. However, this is only a temporary instrument which will retire by 2027.

In the interest of real crisis mitigation the E.U. needs to take a leap of faith and create a mechanism for the establishment of the euro as a global reserve currency. This concept isn’t new. The issue of common bond issuances have been around “even before the euro area was launched” (Favero, 2011). Because Eurobonds enable risk sharing, they tend to equalize borrowing rates for all member states, erasing any deviance in market access. Hence, these assets would effectively level the playing field, creating a safe-haven for global financial flows as an alternative to US Treasuries. Eurobonds must be understood within the context of increasing economic integration of member states, debt crisis prevention, financial stability and as a means for a stronger more resilient Europe.

In summation, fiscal policy in the E.U. took an unconventional turn during the economic crisis of 2009. Austerity did not work out in the end, having negative effects on growth as well as controversial socio-political consequences for Greece. If aspirations of a united Europe are still intact, then the E.U. needs to shift away from neoliberal politics and begin acting as one entity, through policy that promotes collectivism and solidarity. Considering the recurrence of crises over the past 15 years, the E.U. can no longer be a bystander, it must create stable and resilient financial architecture. The only way to do that is through a collectivist framework for fiscal policy.


Bank of Italy, 2019. Testimony on the functioning of the European Stability Mechanism and the prospects for its reform given by Ignazio Visco. Rome, Bank of Italy.

Blyth, M., 2013. Austerity: The History of a Dangerous Idea. New York: Oxford Univeristy Press.

CARLO FAVERO, A. M., 2011. Sovereign Spreads in the Euro Area. Which Prospects for a Eurobond?. Warsaw, Economic Policy.

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Jackson, J. K., 2011. Limiting Central Government Budget Deficits: International Experiences, s.l.: Congressional Research Service.

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Streeck, W., 2013. Will expansion work on mark blyth, austerity: The history of a dangerous idea. Comparative European Politics, 11(6), p. 722–728.

Theofanis Papageorgiou, S. K. A. P., 2021. Neoliberalism and rationality: a tango for two?. Journal of Socialist Theory, 49(3-4), pp. 359-378.

Thomsen, P. M., 2019. The IMF and the Greek Crisis: Myths and Realities: Internation Monetary Fund. [Online] Available at: [Accessed 1 November 2022].

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[1] A term coined by the economist Rob Parenteau. Krugman, P., 2015. The case for cuts was a lie. Why does Britain still believe it? The austerity delusion. [Online] Available at: [2] Council Regulation (EU) No 407/2010, “establishing a European financial stabilization mechanism”. [3] The establishment of the ESM was accompanied by a special amendment to the Treaty on the Functioning of the European Union (art. 136(3)). [4] Ibid Krugman 2015 [5] Ibid Krugman 2015.


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