Paul Krugman writes:
UK, Not OK: The bad GDP number for the UK isn’t a surprise — in fact, judging from market response, investors seem to have expected something even worse. Still, if you step back and look at what has been happening, it’s doubleplusungood: zero growth over the past 6 months, with every reason to be worried on the downside looking forward, as Cameron’s austerity bites deeper. Jonathan Portes gets to the nub of it.... Portes hits, in particular, on a point I’ve tried to make a number of times, here and more recently here: right now, we’re living in a world in which basic economics points to conclusions utterly at odds with what Very Serious People are supposed to believe, in which radical outsiders base their views on standard economics while orthodox types turn to heterodox, highly dubious speculations.
Econ 101, buttressed if you like by fancier New Keynesian models, says that contractionary fiscal policy is, well, contractionary. Yet much of the world of movers and shakers bought into the exotic notion that expectational effects — the confidence fairy — would make contractionary policy expansionary. And they clung to this belief even as the supposed historical evidence in favor of expansionary austerity was thoroughly debunked. And now we’re watching Econ 101 in the process of being confirmed. I wish I thought this would change anyone’s mind.
I must say that I, back in 2007, would not have believed that the world would turn out to be as fundamentalist-Keynesian as it has turned out to be. I would have said that there are full-employment equilibrium-restoring forces in the labor market which we will see operating in a year or two to push the employment-to-population ratio back up. I would have said that the long-run funding dilemmas of the social insurance states would greatly restrict the amount of expansionary fiscal policy that could be run before crowding-out became a real issue.
I would have been wrong.