Paul Krugman writes:
Does Fiscal Austerity Reassure Markets?: For the most part, this debate has been between those like me and Brad DeLong, who assert that budget-cutting should be postponed until we’re no longer in a liquidity trap, and those who insist that we must cut immediately, even though it would inflict economic damage and do little to improve the long-run budget position, because immediate cuts are necessary to achieve credibility with the markets.
I would add that we really should be taking steps now to significantly improve the long-term deficit picture: standby tax increases and spending caps and entenched via procedures in such a way that it would be very, very difficult to undo them. This congress could pass a VAT to be implemented in five years if the budget deficit then still exceeds some trigger value. That would do much more to actually improve the long-term budget position and in all likelihood do more to give markets confidence than pointless exercises in unemployment-creating austerity today.
But does the market need confidence? I think the market right now has plenty of confidence with respect to the core countries--U.S., England, Germany, Japan. And Paul agrees:
My response, and Brad’s, has been to say that right now there’s no hint in the data that the United States (or the UK) has a problem with the markets, and to question why the deficit hawks are so sure about what the market will want in the future, even though it doesn’t want it now...
Today, however, Paul wishes to raise another question: Herbert Hoover's and Heinrich Bruening's tax increases and spending cuts in the early 1930s did nothing to raise confidence--rather they destroyed it by deepening the Great Depression. Won't markets--real markets, populated by real people placing their and their clients' money on the line, not blatherers in op-ed columns claiming what markets think--believe that fiscal austerity today will do the same?
But I suddenly realized this morning that there’s yet another question for the deficit hawks: what evidence do you have that fiscal austerity of the kind you’re demanding would reassure markets, even if they did lose confidence?... Ireland and Spain... appeared, on the surface, to be fiscally responsible until the crisis hit, with balanced budgets and relatively low debt.... [W]hen the bubbles burst they plunged into deficit — and found themselves potentially on the hook for large bank losses. The countries responded differently, however. Ireland quickly embraced harsh austerity; Spain has had to be dragged into austerity, and still faces major political unrest...
So how's it working for you?
Paul then quotes Ian Traynor and Katie Allen of the Manchester Guardian as a typical assessment:
Economic growth: Recession of -0.9% this year, 3% growth next year. National debt as percentage of GDP: 77.3%. Budget deficit as percentage of GDP: 14.7%Cuts: Austerity package includes public-sector pay cuts of up to 20%, plus reductions in child benefit, tax rises, and nurses, teachers, and police officers being laid off. Outlook: Crash burst Irish asset bubble. Much bitterness but also stoicism; markets impressed by Irish resolve to bite the austerity bullet
And back to Paul:
[I]t describes the Irish as doing what has to be done, while the Spaniards dither. And it has good things to say about how the Irish response is working.... Well, I guess that’s right — if by “markets impressed” you mean a CDS spread of 226 basis points, compared with 206 points for Spain; not to mention a 10-year bond rate of 5.11 percent, compared with 4.46 percent for Spain.... I might look at the data and conclude that markets actually have less confidence in Ireland than they do in Spain, and that austerity in the face of a deeply depressed economy doesn’t actually reassure markets at all.
But hey, what are you going to believe: what everyone knows, or your own lying eyes?