What lessons does history have to teach us about Jean-Claude Trichet’s call for immediate, rapid, and substantial fiscal and monetary retrenchment and austerity--about his full-throated endorsement of the agenda of the Pain Caucus?
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Well, history tells us that there are times and circumstances when countries’ refusal to listen to calls for retrenchment and austerity has led to economic disaster. Times when a country’s supply of savings is inelastic and more government borrowing leads to sharp rises in and high real interest rates are times in which government budget deficits have drained the pool of savings, reduced private investment, and slowed growth--as they did in the U.S. in the second Reagan and the first Bush administration. Times when monetary and fiscal laxity leads to an expectation that government debt will be monetized and to rapid rises in inflation expectations are times in which policy has made a deep recession to restore price stability inevitable--as happened in the U.S. in the Nixon, Ford, and Carter administrations. And times when irrational exuberance on the part of foreign investors leads a country’s public or private sector to borrow heavily in foreign currency, it needs to pre-emptively retrench before foreign investor exuberance wears off, or else--as happened to East Asia in 1997-8, to Mexico in 1994-5, or to Argentina innumerable times since 1890.