In most cases, the traditional IMF medicine counter-balances fiscal tightening with a devaluation of the exchange rate.
The idea is that as the fiscal tightening squeezes domestic demand and threatens to cause higher unemployment, then a more competitive currency encourages net exports.
Essentially, exports fill the hole left by the retreating government
But this was not possible in the Greek case because the country does not have its own currency – because it joined the euro.
The only way of compensating for this absence was to allow domestic deflation of prices to produce an “internal devaluation”.
What a laugh! We learned in the 1930s that this does not work.
Deflation is extremely slow and painful and, even if it succeeded in improving competitiveness, it would worsen the debt ratio because it reduces the money value of GDP (the denominator of the ratio).
The result is that Greece is on the road to misery, with no obvious escape.
Rolf Englund:
The Germans should remember that Brüning was the finance minister who tried fiscal tightening in the 30s and paved the way for Hitler.
Encyclopedia Britannica Online:
Brüning's austerity measures prevented any renewal of inflation, but they also paralyzed the German economy and resulted in skyrocketing unemployment and a drastic fall in German workers' standard of living.
He helped President Paul von Hindenburg win reelection in the spring of 1932, but on May 30 of that year Brüning resigned, a victim of intrigues by General Kurt von Schleicher and others around Hindenburg.
The immediate cause of his dismissal was his project to partition several bankrupt East Elbian estates. Hindenburg, himself an eastern landowner, considered this plan Bolshevism, and his withdrawal of confidence left Brüning with no choice but to resign.
