The last few years have seen a culture of austerity take hold with European governments eagerly cutting expenditure to bring government debt under control. Analyses like those by Reinhart and Rogoff have warned of the dangers of excessive government debt. But in focusing on government debt, we may have missed the underlying private spending splurge which preceded the crisis.
In addition, the diagnosis of the causes of the crisis underlying these proposals is wrong. Let me elaborate on this. It is now repeated continuously that the source of the debt crisis in the Eurozone is the profligacy of national governments. As was stressed earlier, prior to the emergence of the financial crisis the government debt to GDP ratio in the Eurozone was declining. During the same period, private debt (households and financial institutions) increased in an unsustainable way.