The Austerity Delusion

The Austerity Delusion
By PAUL KRUGMAN
Published: March 24, 2011

Portugal’s government has just fallen in a dispute over austerity proposals. Irish bond yields have topped 10 percent for the first time. And the British government has just marked its economic forecast down and its deficit forecast up.

What do these events have in common? They’re all evidence that slashing spending in the face of high unemployment is a mistake. Austerity advocates predicted that spending cuts would bring quick dividends in the form of rising confidence, and that there would be few, if any, adverse effects on growth and jobs; but they were wrong.

It’s too bad, then, that these days you’re not considered serious in Washington unless you profess allegiance to the same doctrine that’s failing so dismally in Europe.

It was not always thus. Two years ago, faced with soaring unemployment and large budget deficits — both the consequences of a severe financial crisis — most advanced-country leaders seemingly understood that the problems had to be tackled in sequence, with an immediate focus on creating jobs combined with a long-run strategy of deficit reduction.

Why not slash deficits immediately? Because tax increases and cuts in government spending would depress economies further, worsening unemployment. And cutting spending in a deeply depressed economy is largely self-defeating even in purely fiscal terms: any savings achieved at the front end are partly offset by lower revenue, as the economy shrinks.

So jobs now, deficits later was and is the right strategy. Unfortunately, it’s a strategy that has been abandoned in the face of phantom risks and delusional hopes. On one side, we’re constantly told that if we don’t slash spending immediately we’ll end up just like Greece, unable to borrow except at exorbitant interest rates. On the other, we’re told not to worry about the impact of spending cuts on jobs because fiscal austerity will actually create jobs by raising confidence.

How’s that story working out so far?

Self-styled deficit hawks have been crying wolf over U.S. interest rates more or less continuously since the financial crisis began to ease, taking every uptick in rates as a sign that markets were turning on America. But the truth is that rates have fluctuated, not with debt fears, but with rising and falling hope for economic recovery. And with full recovery still seeming very distant, rates are lower now than they were two years ago.

But couldn’t America still end up like Greece? Yes, of course. If investors decide that we’re a banana republic whose politicians can’t or won’t come to grips with long-term problems, they will indeed stop buying our debt. But that’s not a prospect that hinges, one way or another, on whether we punish ourselves with short-run spending cuts.

Just ask the Irish, whose government — having taken on an unsustainable debt burden by trying to bail out runaway banks — tried to reassure markets by imposing savage austerity measures on ordinary citizens. The same people urging spending cuts on America cheered. “Ireland offers an admirable lesson in fiscal responsibility,” declared Alan Reynolds of the Cato Institute, who said that the spending cuts had removed fears over Irish solvency and predicted rapid economic recovery.

That was in June 2009. Since then, the interest rate on Irish debt has doubled; Ireland’s unemployment rate now stands at 13.5 percent.

And then there’s the British experience. Like America, Britain is still perceived as solvent by financial markets, giving it room to pursue a strategy of jobs first, deficits later. But the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback. As I like to put it, the Cameron plan was based on belief that the confidence fairy would make everything all right.

But she hasn’t: British growth has stalled, and the government has marked up its deficit projections as a result.

Which brings me back to what passes for budget debate in Washington these days.

A serious fiscal plan for America would address the long-run drivers of spending, above all health care costs, and it would almost certainly include some kind of tax increase. But we’re not serious: any talk of using Medicare funds effectively is met with shrieks of “death panels,” and the official G.O.P. position — barely challenged by Democrats — appears to be that nobody should ever pay higher taxes. Instead, all the talk is about short-run spending cuts.

In short, we have a political climate in which self-styled deficit hawks want to punish the unemployed even as they oppose any action that would address our long-run budget problems. And here’s what we know from experience abroad: The confidence fairy won’t save us from the consequences of our folly.

Austerity Britain may not be austere enough, says top think tank

http://www.citywire.co.uk/money/aust...test-news-list

British Debt Best as Cameron U.K. Austerity Makes BOE Pause

http://www.businessweek.com/news/201...boe-pause.html

Austerity justified by Portugal's plight

http://www.dailymail.co.uk/debate/ar...cial-hand.html

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Who to believe? Krugman wants Portugal to keep on spending which means they'd have to keep on borrowing, and at extremely high rates. That doesn't sound like a good idea to me. Are there enough "rich" in Portugal to tax?

Well how have the results of austerity turned out? Is the following true or false?

"Just ask the Irish, whose government — having taken on an unsustainable debt burden by trying to bail out runaway banks — tried to reassure markets by imposing savage austerity measures on ordinary citizens. The same people urging spending cuts on America cheered. “Ireland offers an admirable lesson in fiscal responsibility,” declared Alan Reynolds of the Cato Institute, who said that the spending cuts had removed fears over Irish solvency and predicted rapid economic recovery.

That was in June 2009. Since then, the interest rate on Irish debt has doubled; Ireland’s unemployment rate now stands at 13.5 percent.

And then there’s the British experience. Like America, Britain is still perceived as solvent by financial markets, giving it room to pursue a strategy of jobs first, deficits later. But the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback. As I like to put it, the Cameron plan was based on belief that the confidence fairy would make everything all right.

But she hasn’t: British growth has stalled, and the government has marked up its deficit projections as a result."

Austerity v Stimulus
Robert Skidelsky
The Northern Ireland Economic Conference, Belfast | Wednesday, September 29, 2010

How much do people mind the deficit? Do they lie awake at night worrying about it? Do they have nightmares about it?

I tended to dismiss such thoughts as fanciful. Households and businesses, I thought, naturally worried about their own budgets, but not about the government’s budget.

I therefore tended to assume that the government had enough freedom over its own budget to do what it thought best for the country, without coming under undue popular pressure to ‘balance its books’.

Of course there were the ‘markets’. But it didn’t seem to me the markets were putting pressure on our government to ‘balance the books’. After all they have been lending to Treasury long-term at 3% This is historically very low. It does not suggest any great fear of default or inflation. The markets can certainly make their displeasure felt, as Greece, Portugal, Ireland, and Spain have discovered. But it did not seem to me that a British government, of whatever stripe, faced this particular problem.

But I was brought up short by Alastair Darling in his speech of 27th September at the Labour party conference. The Evening Standard’s headline was: ‘Failure to cut debt would be electoral disaster, says Darling’. He is reported as saying:

‘Whatever our message, it’s got to strike a chord with millions of ordinary people as being realistic and credible. People know there is a deficit. They know it needs to come down. If we deny that, frankly people will not listen to you’.

So, it seems, people do worry about the deficit, perhaps even have nightmares about it. The Coalition, Darling implied, has struck the right cord.

Darling comes across as a solid citizen, in tune with ordinary people. So I ask myself: what is it that ordinary people fear or dislike about the deficit? I have come up with two answers.

First, people think of the government’s finances very much as they think of their own household’s finances.

Every household knows that it has to balance its books. If it is spending more than it’s earning, it either has to earn more or spend less. Spending less means saving more. Yes it can borrow, but borrowing is for emergencies, and has to be repaid. It is better to stay out of debt. True enough, households went on a huge spending spree. Now is the day of reckoning: the wages of sin have to be paid. Households also know that a lot of their spending is ‘wasteful’ –things they can do without. And they assume the same is true of governments.

Ordinary people, I suspect, think of the government as a huge household, which is currently spending much more than it is earning. Its collateral –the national economy – has shrunk in value. So it has to increase its earnings –raise taxes –or reduce its spending, or some mixture of both, and make provision for repaying its debt out of its surplus, just like the millions of smaller households in the land.

I believe that an analogy like this underlines much of the popular feeling that it’s time for the government to start balancing its books.

But the analogy is not, perhaps, enough to create the demand. People also think of the impact of the national debt on their own finances.When they think of the government ‘paying back’ the national debt, they understand that it is they –the taxpaying citizens –who will be doing the paying. So they want to stop the growth of the National Debt, and that means reducing the deficit as quickly as possible. It’s the debt not the deficit which looms largest in people’s minds. Unless the books are balanced now, the burden on present and future tax payers will skyrocket. In fact it already portends a new age of austerity.

So the demand for retrenchment comes both from the analogy between households and governments and from the implied financial link between the two.

These are instinctual responses. But they are inflamed by politicians. David David Cameron has said that ‘the government deficit is just like credit card debt’. George Osborne has repeatedly pointed out that borrowing is simply deferred taxation.

However, these are not the only instinctual responses. There is also, I would say, a strong instinctual understanding that cutting the deficit is likely to cost jobs. This is the trade union position. It was the great fault of the Labour Party leadership that it failed to develop a persuasive narrative capable of giving this instinct voice.

One should not underestimate the effect of language. Politicians use language to create a particular kind of narrative. The phrase ‘deficit denial’ is a conscious echo of the phrase ‘Holocaust denial. A ‘denier’ is someone who refuses to acknowledge the existence of a disagreeable fact. A deficit denier is someone who minimises the deficit problem, and therefore the need to take urgent action. The cutting narrative can also be seen in the emphasis of the cutters on the ‘structural deficit’. By some alchemical process which is far from clear the pre-recession deficit of 2.5% of GDP has been transmuted into a ‘structural deficit’ of 7.4%. This, the cutters say, is the real legacy of the last government – of its wastefulness and extravagance. ‘Deficit deniers’ are those weak sisters who blame most of the deficit on the collapse of the economy rather than on thirteen years of Labour government and say that most of it will shrink naturally as the economy recovers.


And the rest:

http://www.skidelskyr.com/site/artic...ty-v-stimulus/

And one more for good luck!

Britain’s Austerity Apostles Duck the Debate
Robert Skidelsky
Financial Times | Thursday, October 14, 2010

Next week the parliamentary battle over cuts will start up again. The chancellor, George Osborne, will say the government’s programme of fiscal retrenchment is necessary to “restore confidence”. Alan Johnson, his shadow, will say it threatens the “fragile recovery”. The government plans to cut public spending by 10 per cent over four years as part of its deficit reduction plan. This will extract 5 per cent out of a shrunken economy. It is the most audacious axe-cutting exercise in almost a century, double the size of the cuts in the 1930s, equalled only by the 1921 Geddes Axe, which cut government spending by 11 per cent in two years. Labour says it is too much, too fast.

The two positions are clear enough, the arguments underlying them less so. What macroeconomic theory do the budget hawks have to subscribe to, to believe that taking £100bn out of the economy in the next four years will produce recovery? And what do the budget doves need to believe to claim the cutters are wrong?

David Cameron, Mr Osborne, and Nick Clegg appear to believe in something called “crowding out”. This is the view that for every extra pound the government spends, the private sector spends one pound less. Jobs created by stimulus spending are jobs lost by the decline of private spending. Any stimulus to revive the economy is doubly damned: not only does it fail to stimulate, but, because government spending is less efficient than private, it reduces the economy’s longer term recovery potential.

Applied to the deficit, the “crowding out” thesis takes two forms. The first is “Ricardian equivalence’’. Government borrowing is simply deferred taxation, because it produces no revenue to pay for it. Households save more to pay the higher taxes they expect. This means that any extra income created by the deficit will be saved, not spent. Net stimulus: zero.

The other leg of the “crowding out” argument is that government borrowing causes interest rates to rise. There is a fixed lump of saving. The more the government borrows, the more private borrowers will have to pay for their loans.

A refinement of this argument is “psychological crowding out”. In this version it is not a shortage of saving, but a shortage of confidence in the government’s creditworthiness – due to a fear of default – which causes interest rates to rise. Either way the deficit “crowds out” private investment. Net stimulus: zero.

The supposed implication of this type of argument is that in the short-run the deficit can do no good; and that in the slightly longer term it harms the potential for recovery. What the cutters have to believe is that every pound of deficit reduction will be matched by an extra pound of private sector spending. That is, if the government weren’t spending this money, the private sector would be, and making much better use of it. Mr Osborne’s programme is a beautiful cure for recession, provided there’s no recession to cure!

Keynesians do not deny the possibility of “psychological crowding out”: markets are subject to all kinds of irrational hopes and fears. But what the cutters mean by “crowding out” can normally only happen at full employment. At full employment, extra public spending obviously subtracts from private spending. But this is not the position we are in today.

What Keynesians say is that when resources are unemployed, government borrowing is not deferred taxation: it brings resources into use that would otherwise be idle, and thus increases the government’s revenues without having to raise taxes. When the government borrows money for which there is no current business use, this increases people’s incomes and therefore the saving needed to finance the borrowing, without interest rates having to rise. And though confidence problems may occur even in an under-employed economy, the probability of the UK government defaulting on its debt is, if not zero, extremely low.

In short, the “crowding out” argument is false. The problem is not the expansion of the deficit but the shrinkage of the economy. The deficit is the stimulant the economy needs to start growing again: its withdrawal guarantees stagnation or worse.

Why aren’t we having this argument? The reason is that, against its instincts, the last Labour government accepted the pre-Keynesian economics of the cutters and sought only to ease the pain of the axe. To promise to cut a little less, and a little slower, than the coalition is an improvement, but not an alternative economic strategy. Only Ed Balls has the economic confidence and pugnacity to argue the Keynesian case. For political reasons he has been denied the shadow chancellor’s job.

I would sum up this way. When an economy is growing to trend with a low level of unemployment, “crowding out” applies, and the budget ought to be balanced at modest level of taxes and spending. But when it has large unemployed resources, the Keynesian theory is best, and the government should not be ashamed of running a deficit. A properly Keynesian opposition would say that the budget balance should be dictated by economic circumstances, not by some arbitrary timetable: who knows what the situation will be in two, three, four years’ time? But I doubt if this opposition will have the courage to do so.

Thanks for those old stale articles lol.

Spending what you don't have cannot be a good idea.

Skidelsky has NEVER been referred to as "stale". He was just on Bloomberg radio (hardly a liberal bastion) in the last hour and is well respected. Open your ears and mind.

You never did answer my question.

Is the following true or false?

"Just ask the Irish, whose government — having taken on an unsustainable debt burden by trying to bail out runaway banks — tried to reassure markets by imposing savage austerity measures on ordinary citizens. The same people urging spending cuts on America cheered. “Ireland offers an admirable lesson in fiscal responsibility,” declared Alan Reynolds of the Cato Institute, who said that the spending cuts had removed fears over Irish solvency and predicted rapid economic recovery.

That was in June 2009. Since then, the interest rate on Irish debt has doubled; Ireland’s unemployment rate now stands at 13.5 percent.

And then there’s the British experience. Like America, Britain is still perceived as solvent by financial markets, giving it room to pursue a strategy of jobs first, deficits later. But the government of Prime Minister David Cameron chose instead to move to immediate, unforced austerity, in the belief that private spending would more than make up for the government’s pullback. As I like to put it, the Cameron plan was based on belief that the confidence fairy would make everything all right.

Thanks for the link Alexmai.

Lloyd, I know you wish me to answer your questions, but if you will, imagine the alternative of Ireland continuing to spend. It's absurd. I'll remind you for the last time, Ireland has no monetary policy. They can't print money. For them, it is a matter of revenues and expenses. To get your "fiscal house" in order, you need to either collect more tax revenue, or cut spending. Continued borrowing is not the answer, and that's what Krugman is endorsing.

I was simply pointing out and demonstrating with Krugman's examples that austerity programs havent delivered the results that supporters have professed. To say you shouldnt spend AT ALL now is silly. Its always about priorities. There is time to bring down debt and spend in the areas that will help our economy grow into the future. The problem is that this has become a political football (rhetoric is out of control) not to mention that there are legitimate differences in philosophy about how to allocate resources and we are stalemated unless and until some kind of compromise can be worked out.

I can agree to that.

Did you see Alexmai's link? I think you posted Stockman's position on the "Bush Tax Cuts" back in December prior to the extension. I think it summarizes the lunacy in government today.

Yes i saw his link. Who is that Miami Dade politician on the right side of the page? LOL.
I like Stockman. Yes, i posted his opposition to the extension of the Bush tax cuts. Dont agree with everything he has to say, but he is certainly way less "political" then almost all Republicans in govt today. I admire his willingness to say what he believes even if its unpopular in his own party. Need more people like him on both sides.

"First, people think of the government’s finances very much as they think of their own household’s finances."

That quote from the earlier article is at the root of many people's lack of understanding - and of course - ideology misinstructs also.

To stimulate what is moribund is the answer in this instance. How you do it is negotiable. Those that want "austerity" have other "reasons" beside being thrifty.

Wisconsin, and many other examples, (The Shock Doctrine, by Naomi Klein) are conclusive evidence.