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A tale of two PIIGS

Here's a chart that should strike fear into the hearts of Keynesian economists. It compares the yield on 2-yr Irish and Greek sovereign debt, one of which has soared, while the other has plunged. Both face massive deficits: one country's deficit/GDP ratio is 10.5%, while the other's is perhaps the worst on the entire planet: a staggering 32.4%, according to Bloomberg. Can you guess which is which? Wrong. Ireland has the worst deficit/GDP ratio, but its prospects for recovering are much better than Greece's, mainly because Ireland has decided to tighten its belt and adopt genuine austerity measures that reject tax hikes (Ireland has steadfastly refused to pay attention to the EMU's entreaties to raise its corporate tax rate to a level more consistent with other countries) in favor of spending cuts. Ireland has decided to bite the bullet, and they are doing it in convincing fashion. This gives markets the confidence they need to prefer Irish debt to Greek debt, and by a huge margin.

The U.S. debt problem is no more complicated than Ireland's. All we need to do is take convincing steps to rein in spending while eschewing tax hikes. That improves the outlook for growth, and that in turn provides a bedrock of confidence.

Why should Keynesians be worried? Because this is concrete proof that cutting spending and keeping taxes low can actually improve a country's economic outlook.

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