Gavyn Davies Aside, It Now Appears that the Claim that Immediate Austerity Right Now Is Disastrous Is No Longer Highly Contested, at Least Among Fair-Minded People
Of course, it never was highly contested, among fair-minded people who had done their homework.
The Great Anti-Keynesian Flip-Out: Keynesian economists made some pretty clear predictions around 3 years ago – predictions that were very much at odds with what anti-Keynesians were saying. We said that as long as the economy remained deeply depressed, even a huge rise in the monetary base would not be inflationary, and that even huge budget deficits would not send interest rates soaring. And we said that fiscal austerity would be contractionary, not expansionary.
All these predictions have been borne out….
But some anti-Keynesians have tried to save their dignity, or something, by attacking supposed Keynesian propositions that nobody actually, you know, proposed. The usual one is to claim that Keynesians predicted great results from the Obama stimulus (which I very noisily did not). But Tyler Cowen has come up with something truly strange. He seems to believe that any good news anywhere somehow refutes Keynes. Hints of recovery in Ireland (which proved a false dawn)? Keynesianism is wrong! A relatively encouraging month on the jobs front? Keynesianism is wrong!
I’d say that this was attacking a straw man, but that would be an insult to straw men. What is going on in Cowen’s head?
Debating economic policy: Stimulus, austerity and the weltgeist: While independent economists generally agree that [Obama's Recovery Act] stimulus saved or created somewhere in the neighbourhood of 2m jobs, it remains unpopular with the general public; the sense was that there was no point engaging on this issue, regardless of the merits. Now ProPublica's Mike Grabell is out with a book-length investigation of the stimulus, titled "Money Well Spent?"…
Mr Grabell said… money funneled to states to forestall budget cuts saved huge numbers of jobs for teachers, firefighters and other employees, and delayed cutbacks in infrastructure spending. He subscribes to the general wisdom that unemployment probably would have hit 12% in 2009 rather than 10% without it. On the other hand, the administration had to drop an idea that almost certainly would have made sense—building a national electric smart grid—because the jurisdictional and red-tape problems made it impossible to implement fast enough. Instead the administration decided to invest in clean energy; but those investments placed their bets too heavily on individual companies, some of which then went bankrupt. In an excerpt from the book on the electric car and battery industry jump-started by stimulus funding, Mr Grabell says the jury is still out: without a rapid pickup in demand for Leafs and Volts (which in turn depends on a big increase in electric charging stations), America's electric-car industry will probably fail to hit critical mass, and it'll wind up relocating to South Korea or China like every other manufacturing industry has.
So, here's the thing. The debate we had about the stimulus probably should have been a lot like the book Mr Grabell has written: a detailed investigation of what does and doesn't work…. But that wasn't the debate we had. Instead we had a debate about the very concept of whether the government ought to spend money counter-cyclically during a recession in order to keep the economy from collapsing, or whether it should tighten its belt along with consumers and businesses in order to generate confidence in the financial markets and allow markets to clear. We had a debate about whether governments should respond to recessions with deficit spending or austerity.
That was the debate we had. And what's interesting about this particular moment is that while Mr Grabell is writing about what did and didn't work in the stimulus, and Mr Obama is staying away from the topic for political reasons, out there on the barricades what's happening is that the entire argument that governments should engage in austerity appears to be collapsing.
Item 1: Over the past month, Paul Krugman, Brad DeLong, and Simon Wren-Lewis engaged in an interminable duel with Tyler Cowen, Scott Sumner, sort-of Karl Smith (occupying as usual an esoteric position not easily placed on the ideological grid), and probably some other people I'm forgetting—over an old argument by John Cochrane claiming that the multiplier effect of government stimulus spending probably ought to be zero. The argument by Mr Cochrane was a critical document in the stimulus debate, because it was an articulation in more-or-less public discourse by a well-respected economist of a mechanism through which increased government spending could fail to raise GDP or increase employment at all. Essentially every working practical economist and forecaster believed that the stimulus, like any other government spending, would raise aggregate demand, GDP, and employment. Republican politicians were arguing that it would not, and Mr Cochrane backed them up.
Two weeks ago, Mr Cochrane responded to the argument in a fashion that suggested that either he has changed his mind, or he never thought what the expansionary-austerity people claimed he did in the first place.
Let's be clear what the "fiscal stimulus" argument is and is not about. It is not about the proposition that governments should run deficits in recessions. They should, for simple tax-smoothing, consumption-smoothing, and social-insurance reasons, just as governments should finance wars with debt. That doesn't justify all deficits—one can still argue that our government used the recession to radically increase permanent spending. But disliking "stimulus" is not the same thing as calling for an annually balanced budget.Nor is it about debt financing of "infrastructure" or other genuine investments. If the project is valuable, do it. And recessions, with low interest rates and available workers, are good times to do it... Stimulus [is] still an economically interesting proposition, and there is a great deal of uncertainty about whether, when, and how well it might work.
Okay. There's a lot of nuance here. But as Noah Smith pointed out in response, if the basic gist is that governments should run deficits in recessions to smooth consumption, deliver social insurance, and take advantage of low interest rates to invest in infrastructure... then the policies Mr Cochrane is recommending here are to the left of anything Congress is contemplating….
Item 2: Niall Ferguson has spent the last three years arguing, contra Paul Krugman, that America is courting disaster by allowing deficits to balloon its national debt to such high levels, and will have to reign in spending or face a crippling rise in interest rates. Last week, in an interview with Henry Blodget, he admitted defeat.
BLODGET: That is a shockingly optimistic view of the United States from you. Are you conceding to Paul Krugman that over the near-term we shouldn't worry so much?
FERGUSON: I think the issue here got a little confused, because Krugman wanted to portray me as a proponent of instant austerity, which I never was. My argument was that over ten years you have to have some credible plan to get back to fiscal balance because at some point you lose your credibility because on the present path, Congressional Budget Office figures make it clear, with every year the share of Federal tax revenues going to interest payments rises, there is a point after which it's no longer credible. But I didn't think that point was going to be this year or next year. I think the trend of nominal rates in the crisis has been the trend that he forecasted. And you know, I have to concede that.
I could go on...
And some historical documents:
Paul Krugman: Myths of Austerity: July 1, 2010: When I was young and naïve, I believed that important people took positions based on careful consideration of the options. Now I know better. Much of what Serious People believe rests on prejudices, not analysis. And these prejudices are subject to fads and fashions. Which brings me to the subject of today’s column. For the last few months, I and others have watched, with amazement and horror, the emergence of a consensus in policy circles in favor of immediate fiscal austerity. That is, somehow it has become conventional wisdom that now is the time to slash spending, despite the fact that the world’s major economies remain deeply depressed. This conventional wisdom isn’t based on either evidence or careful analysis. Instead, it rests on what we might charitably call sheer speculation, and less charitably call figments of the policy elite’s imagination — specifically, on belief in what I’ve come to think of as the invisible bond vigilante and the confidence fairy….
What’s the evidence for the belief that fiscal contraction is actually expansionary, because it improves confidence? (By the way, this is precisely the doctrine expounded by Herbert Hoover in 1932.) Well, there have been historical cases of spending cuts and tax increases followed by economic growth. But as far as I can tell, every one of those examples proves, on closer examination, to be a case in which the negative effects of austerity were offset by other factors, factors not likely to be relevant today. For example, Ireland’s era of austerity-with-growth in the 1980s depended on a drastic move from trade deficit to trade surplus, which isn’t a strategy everyone can pursue at the same time.
And current examples of austerity are anything but encouraging…
Paul Krugman: Liquidity preference, loanable funds, and Niall Ferguson: May 2, 2009: Joe Nocera writes about Thursday’s New York Revie/PEN event on the economy, but fails to mention what I found the most depressing aspect of the whole thing: further confirmation that we’re living in a Dark Age of macroeconomics, in which hard-won knowledge has simply been forgotten.
What’s the evidence? Niall Ferguson “explaining” that fiscal expansion will actually be contractionary, because it will drive up interest rates. At least that’s what I think he said; there were so many flourishes that it’s hard to tell. But in any case, this is really sad: John Hicks knew far more about this in 1937 than people who think they’re sophisticates know now….
Right now the interest rate that the Fed can choose is essentially zero, but that’s not enough to achieve full employment. As shown above, the interest rate the Fed would like to have is negative. That’s not just what I say, by the way: the FT reports that the Fed’s own economists estimate the desired Fed funds rate at -5 percent…. So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap.
Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.
Paul Krugman: A history lesson for Alan Meltzer: May 4, 2009: From today’s Times:
Besides, no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation as we are has ever experienced deflation. These factors are harbingers of inflation.
Japan’s lost decade.