By Malcolm Moore
January 17, 2012 | The Telegraph
Imposing austerity measures as countries slow towards recession is a fundamentally flawed response, said Mr Stiglitz, who won the Nobel prize in 2001 for his work on how markets work inefficiently.
"The answer, even though they see over and over again that austerity leads to collapse of the economy, the answer over and over [from politicians] is more austerity," said Mr Stiglitz to the Asian Financial Forum, a gathering of over 2,000 finance professionals, businessmen and government officials in Hong Kong.
"It reminds me of medieval medicine," he said. "It is like blood-letting, where you took blood out of a patient because the theory was that there were bad humours.
"And very often, when you took the blood out, the patient got sicker. The response then was more blood-letting until the patient very nearly died. What is happening in Europe is a mutual suicide pact," he said.
Keynesian economics, which require governments to help sustain demand, suggests that austerity measures should be imposed when an economy is booming, not waning.
Mr Stiglitz pointed out that 700,000 public sector jobs had been cut in the United States in the past four years, removing demand from the system as unemployment spikes. The UK is set to lose a similar number by 2017.
Instead, Mr Stiglitz argued the best economic medicine is infrastructure spending, especially on transport and energy projects. He pointed to China as one country that had successfully combatted financial crises with stimulus packages.
On Monday, George Osborne had told the same forum that the UK's fiscal austerity measures, which have been in place for a year and under which the economy has begun to tip into recession, were the only way to convince the market of the UK's economic credibility.
"When you have a high budget deficit, if you do not have a [disciplined fiscal] plan then you will not have sustainable growth because investors will be worried about investing in your country," the Chancellor said.
However Mr Stiglitz argued that austerity in the UK and elsewhere would not boost confidence. "There will not be a restoration of confidence as long as economies keep falling, and that will continue until [politicians] change economic course. And I do not think that is likely," he said.
Mr Stiglitz said economists are now not debating if the Euro will break up, but how and when it will happen.
"Among economists the discussion is about the best way to end the euro. It could be civilian upset that does it. Youth unemployment in Spain has been over 40pc since 2008. How much longer will they tolerate that? The policies of the new government are for more of the same medicine, except worse.
"The other way it may end is when the European Central Bank refuses to be the lender of last resort for some countries, precipitating a crisis. We can be sure that markets will be highly volatile and the end of the Euro will be a very severe disruption to the global economy," he said.
However, he compared the strictures of the single currency to the gold standard, and noted that countries which had abandoned the gold standard early had recovered more quickly.
"When the Euro was founded, most economists were skeptical," he said, noting that the single currency was a political project that had not satisfied the optimum conditions for a currency bloc. "They hoped they would be able to finish the project over time, but the politics was not strong enough," he said.
Mr Stiglitz also said that while he was critical of the ratings agencies, a decision to downgrade the European Financial Stability Fund (EFSF) on Monday was reasonable. "The EFSF was trying to leverage something out of nothing, and that was never going to work, and they were just saying that it wasn't going to work," he said.
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