By Kevin Hassett

The best medicine can taste awful.

The governments of the U.K., Ireland and Greece have embarked upon ambitious, sometimes painful efforts to restore their economies to sustainable growth paths. Of the three, the U.K. and Ireland took their medicine, following the lessons of past efforts to pull national economies away from spiraling debt. Greece decided the taste was just too awful, and its irresponsibility threatens every euro-zone country.

The history of the modern welfare state is replete with examples of fiscal calamities. In good times, politicians expand government spending as far as soaring revenues will let them. In bad times, when the bubble bursts, countries find themselves in a ditch.

Numerous fixes have been tried over the years, and economists have created a cottage industry studying them. What has emerged is a consensus about what works, a consensus that is about as strong as any in the macroeconomics literature.

The antidote to fiscal crisis is fiscal consolidation, a dramatic change in spending and tax policy that reduces the indebtedness of a nation. Such consolidations have relied on varying degrees of tax increases and spending reductions. Some have successfully reduced debt, some haven’t. The data tell a clear story: What works is cutting government spending.

A series of influential papers by Harvard University economist Alberto Alesina and various co-authors found decisive evidence that successful consolidations rely almost exclusively on spending reductions, while unsuccessful consolidations seek to close 50 percent or more of the gap with tax increases.

Cutting Is Key

A recent study by the International Monetary Fund supports the principle that cuts, particularly to entitlement programs, are key.

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By SCOTT S. POWELL

Today’s auction of 10- and 30-year US Treasury notes and bonds won’t tell us as much about the US economy as auctions used to — because the Federal Reserve has started buying up the notes as part of Fed Chairman Ben Bernanke’s “quantitative easing” effort.

Until recently, a plentitude of bidders for long-term US government debt was a sign the US economy was strong. But Bernanke is buying that debt in what he says is an effort to make the economy stronger.

This has a lot of people nervous — and the news that the Fed may spend up to $800 billion on this, rather than the $600 billion figure initially given, doesn’t help.

Even if the purpose is to stimulate the economy, increase stock prices and lower interest rates, the effect of Bernanke’s policy may be monetizing the nation’s growing debt — printing new money to finance deficit spending.

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By Vanessa Rossi

Ireland had little choice but to accept European Union help to avoid a breakdown in the financial system. There was no other way to rescue the banks without placing the burden on Ireland’s 4.5 million people.

At the peak of the financial crisis, the U.K. and U.S. were able to provide guarantees worth trillions of dollars to support their banks, though the actual costs turned out to be much lower as confidence was quickly restored. The full extent of the guarantee was largely hypothetical. They succeeded because they could make a credible promise of support — Ireland could not.

The Irish banking meltdown, so soon after the euro-area stress tests this year, raises questions over the reliability of these assessments, which failed to put enough emphasis not just on bad debts but on the risk of relying on the wholesale market for funds. The tests, which covered some banks but not others, will cast doubt on the strength of the remaining European banks.

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