Right at the moment, the failure to adjust to the necessities of a large closed economy is the single largest force behind the crisis. Small open economy thinking has brought us uncoordinated fiscal austerity packages. Jointly, these programmes have had a profoundly negative effect on growth, one that the small open economy crowd was unable or unwilling to see. All forecasts for economic growth and budget deficits have been too optimistic because governments failed to take into account their full impact. Not only Greece and Ireland are missing their targets, but so will Spain and Italy. I expect a full-blown recession in Italy next year, and an overall increase in the deficit. So the net effect of austerity will be an increase in debt.
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