Deficit reduction policies, market credibility and market failure Online publication date: Wed, 14-Jan-2015
by Yiannis Kitromilides
International Journal of Public Policy (IJPP), Vol. 7, No. 1/2/3, 2011
Abstract: The UK coalition government claims that the establishment of market 'credibility' can only be achieved through the implementation of immediate and unpalatable fiscal austerity measures. The paper examines this claim and considers some additional questions. First, is there is any justification for subordinating public policy-making to market sentiment? Do financial markets strengthen or subvert democracies? Are markets 'rational' in the way they define policy 'credibility', or is there a 'market failure'? An example of market failure is the so called 'fallacy of composition' case: if an indebted individual wants to avoid insolvency, adopting personal austerity measures constitutes a 'credible' policy of deficit reduction; the same may not be true for the whole economy. The recent experience with fiscal austerity in Europe suggests that the adoption of rapid fiscal consolidation policies in order to 'appease' the financial markets may in fact be counterproductive.
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