The Road To Austerity

Before Stephen Harper and Dalton McGunity introduce their austerity budgets next month, they would do well to read Paul Krugman's column in this morning's New York Times. The advocates of austerity are everywhere these days. Unfortunately, Krugman writes, they have "substituted moralizing for analysis, fantasizing for the lessons of history."

This is particularly true in Europe, where Greece has become the tar baby no one wants to go near. But the consequences of European economic policy are now clear: "Greece and Ireland have had double-digit declines in output, Spain has 23 percent unemployment, Britain’s slump has now gone on longer than its slump in the 1930s."

Specifically, in early 2010, austerity economics — the insistence that governments should slash spending even in the face of high unemployment — became all the rage in European capitals. The doctrine asserted that the direct negative effects of spending cuts on employment would be offset by changes in “confidence,” that savage spending cuts would lead to a surge in consumer and business spending, while nations failing to make such cuts would see capital flight and soaring interest rates. If this sounds to you like something Herbert Hoover might have said, you’re right: It does and he did.

Now the results are in — and they’re exactly what three generations’ worth of economic analysis and all the lessons of history should have told you would happen. The confidence fairy has failed to show up: none of the countries slashing spending have seen the predicted private-sector surge. Instead, the depressing effects of fiscal austerity have been reinforced by falling private spending. 

Krugman has never argued that debt is no problem. It must be paid down. But timing is everything. And the time to pay it down is not when unemployment is high. Austerity merely creates more unemployment, and deficits rise. Worse still, policy makers become even more divorced from the people in the streets -- who, in turn, become increasingly restless and angry.

That's not a theory. Ask Herbert Hoover.

Is Keynesian Economics Dead?

Robert Samuelson asks that question -- and gives his answer -- in this morning's Washington Post:

Governments have ceded power to bond markets by decades of shortsighted behavior. The political bias is to favor short-term stimulus (by lowering taxes and raising spending), which is popular, and to ignore long-term deficits (by cutting spending and raising taxes), which is unpopular. Debt has risen to hazardous levels, undermining Keynesian economics as taught in standard texts.

Were Keynes alive now, he would almost certainly acknowledge the limits of Keynesian policies. High debt complicates the analysis and subverts the solutions. What might have worked in the 1930s offers no panacea today.

The problem with the austerity solution is that when governments slash spending, they also decrease government revenues -- and deficits continue to balloon. Austerity has not improved Greece's financial situation; just as it did nothing to cure Japan's decades long slump. It's an old story. By focusing on the forest, policy makers don't see the trees. Austerity does not create growth.

It's true that bond markets possess more power than they warrant. One needs only to recall that Moody's, Standard and Poor's and Fitch's rated those sliced and diced mortgages -- which so enriched Wall Street  --  as gold plated investment opportunities. The real question policy makers should ask is, "Why do  the bond raters still have any credibility?" Instead, we kneel before them, humbly seeking their approval.

Debt is a problem. But austerity now makes the problem worse.

This entry is cross posted at The Moderate Voice.