Night of the Living Alesina: Ah, remember the good old days of expansionary austerity?… [A]usterians seized on academic work by Alberto Alesina and Silvia Ardagna claiming that fiscal consolidation, if focused on spending cuts, would if anything lead to economic expansion…. Since then we’ve had what has to be one of the most decisive combinations of scholarly critique and real-world tests…. The IMF went about identifying austerity through an examination of actual policy, and A-A’s results were reversed. Critics showed that all of the alleged examples of expansion through austerity involved factors like currency depreciation or sharp falls in interest rates…. Osbornian policies in the UK led to stagnation; and in the euro area, well….
So you might have expected austerians to change their minds, or at least to come up with other justifications.
Both David Cameron and Paul Ryan are still preaching that old expansionary austerity religion, confidence fairy and all. This is, by the way, a fairly big deal for the Ryan budget, which… keeps the tax hikes that finance Obamacare while canceling the Medicaid expansion and exchange subsidies. The result would be a lot of fiscal drag in 2014 and 2015…. Luckily it isn’t going to happen. And a quick read of reactions suggests that the new Ryan plan is being greeted with derision rather than adulation. Is our pundits learning? A bit, maybe.
The way we put it back in the early 1990s was like this:
(a) Credible commitments to future deficit reduction were expansionary to the extent that they led to (b) rational expectations that the central bank would make short-term interest rates in the future lower which led to lower long-term interest rates now, or (c ) irrational beliefs that the central bank would make short-term interest rates in the future lower which led to lower long-term interest rates now; and (d) current-year deficit reduction could be expansionary to the extent that it boosted the credibility of the commitment to (a) and thus to (b) or (c ) as long as (e) its current-year direct depressing effect on demand was not too large.
This seemed to us to fit the circumstances of the early 1990s. It does not fit circumstances now.