Austerity has been an unmitigated disaster, and this proves it
By Matt O'Brien April 24
There's nothing more dangerous, when it comes to the economy, than getting cause and effect backwards.
That's how slowdowns turn into slumps, recessions turn into depressions, and recoveries turn into relapses. It's what the austerians did, though, when they insisted that cutting the deficit during a depression would actually help the economy by boosting confidence in the government's finances. It's an old fallacy that had been disproved in the 1930s, but came back from the intellectual dead in 2010 when people were looking for any excuse to do the economically inexcusable. So what had been hard-won knowledge became even harder still—if it was at all—as government threw one fiscal hurdle after another in front of the recovery out of fealty to some defunct economists. And that's why the IMF is trying to make sure we don't forget again that, yes, Keynes was right.
It's a pretty simple mistake. When the economy collapses, tax revenues do too, and the deficit goes up—and that's the way the causation runs. But the austerians look at this in reverse. They think the deficit, if not prompting the recession itself, is at least preventing a recovery by either making it too expensive for businesses to invest or scaring them out of doing it in the first place. In the depths of the Great Depression, for example, John Kenneth Galbraith tells us that the head of the New York Stock Exchange thought that "the government, not Wall Street, was responsible for the current bad times" and that the government "could make its greatest contribution to the recovery by balancing its budget and thus restoring confidence." Specifically, he wanted to cut "the pensions and benefits of veterans who had no service-related disability and also all government salaries." It was the same story almost 80 years later when then-European Central Bank chief Jean-Claude Trichet claimed that "the idea that austerity measures could trigger stagnation is incorrect" since "confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today."
But why would businesses that don't have enough customers feel any more confident just because the government cut its spending? Good question. The austerians say it's that there's no such thing as not having enough customers, at least not for the economy as a whole. (If that doesn't make sense to you, don't worry, it doesn't). So if businesses aren't investing, the story goes, the best thing the government could do is to increase the pool of money that's available for investment by cutting its deficit. In other words, for the government to borrow less so the private sector can borrow for less. Not only that, but austerians say every dollar the government borrows is one it will have to pay back with higher taxes—meaning that, if businesses were clairvoyant, deficits would keep them from investing as much today so they could pay back the IRS tomorrow. Add it all up, and austerity should be expansionary, right?
Well, no. Less government borrowing can't lower private sector borrowing costs when interest rates are already zero, like they are now. And if you think you know what today's deficits mean for tomorrow's taxes, well, you probably think again. The private sector, in other words, won't spend any more to offset the government spending less—in fact, it will spend less. And that's not just a theory. That's what has happened. The IMF found that countries that have done austerity have actually had less investment afterwards. And even the ECB, which has forced countries to slash their deficits, now admits that these cuts "affect confidence negatively." This makes sense if you think that tax hikes and spending cuts hurt the economy, and people don't want to invest when the economy looks bad. It doesn't make sense, though, if you think that tax hikes and spending cuts make people feel so much better about the long-term fiscal outlook that they'll invest whether or not they have customers.
But the austerians don't make a lot of sense, do they? Empirical reality has shown over and over again that austerity makes a bad economy even worse, makes weak investment even weaker, and, in the process, shrinks the economy so much that total saving goes down even as these cuts try to force it up. So, as Keynes put it, "the boom, not the slump, is the time for austerity," because anything else is self-defeating. Unless the central bank can offset lower spending with lower interest rates, contractionary policy will be, well, contractionary. Although any of the millions of people who lost their jobs due to policymakers resurrecting an 80-year old delusion could have told you that.
But at least you don't have to wait until the long run for austerity to be dead as an intellectual concept.
Matt O'Brien
