Austerity – procyclical fiscal policy – is thus needed in Latvia exactly because it was procyclical and unsustainable during the boom
One of the interesting – and rather scary – features of the world-wide macroeconomic debate these days is the massive disagreements that exist concerning how to handle the recession. In one corner you have the pro-stimulus people arguing for good old Keynesian countercyclical fiscal policy i.e. increase government spending now to create more jobs and then pick up the tab later when the economy is back on track. In the other corner we have the austerity bunch arguing that budget consolidation is needed i.e. budget deficits must be slashed to avoid unsustainable debt accumulation. Such fiscal policy is procyclical since it follows the economic cycle and exacerbates it, or in other words, a downturn is worsened; unemployment created by lack of demand in the economy is followed by more unemployment as schools and hospitals are closed etc.
