20 February 2012

Austerity and Reality

Paul Krugman still doesn’t get it:
Watching Europe sink into recession – and Greece plunge into the abyss – I found myself wondering what it would take to convince the chattering classes that austerity in the face of an already depressed economy is a terrible idea.
After all, all it took was the predictable and predicted failure of an inadequate stimulus plan to convince our political elite that stimulus never works, and that we should pivot immediately to austerity, never mind three generations’ worth of economic research telling us that this was exactly the wrong thing to do. Why isn’t the overwhelming, and much more decisive, failure of austerity in Europe producing a similar reaction?
Here’s the simple answer:  austerity is not about promoting growth, it’s about getting one’s fiscal house in order, which is to say that austerity is all about reducing government spending and government debt.  More to the point, there are a couple of flaws worth pointing out here.

First, there is the obvious flaw of growth measurements.  Growth measurements include government spending so, by definition, whenever government spending contracts, growth will decline.  Complaining about the lack of growth in light of government budget cuts is like complaining about the definition of wet.

Second, the main problem right now is debt.  Namely, that it has to be paid.  When you borrow from the future, you will eventually hit a point when the money you borrowed is due, with interest.  And that point is here.  People have to pay their debts, which is one reason why austerity is necessary.

Third, and along the lines of the second point, the current situation does not fit in any way with three generations of economic research.  If one were to actually read Keynes’ policy prescription, one would find that it has very little bearing to reality.  Keynes’ fundamental prescription for smoothing out economic turbulence was to raise taxes and save money when the economy was experiencing growth and lower taxes and spend money when the economy was cooling down.  (Incidentally, this very thing has worked at least once in history.)  The problem is that the experts in Washington only did one of those four things.

See, the only part of the policy that Washington followed was increasing spending at the start of the downturn.  Washington lowered taxes during the boom, exacerbating the boom, and then failed to save money for the inevitable decline.  And now that the decline is in full force, Washington is considering raising taxes.  So even if the economic research is correct, it is certainly not being followed in any meaningful way.  As such, appealing to this research is simply ludicrous, as it doesn’t apply anyway.


  1. >debt. Namely, that it has to be paid. When you borrow from the future, you will eventually hit a point when the money you borrowed is due, with interest

    This is certainly true on average, but I think you're making a mistake by upgrading it to a kind of universal physical law. I can cite instances in my own life where I've forgiven peoples' debts. It's often good to forgive debts when the friction they cause to a friendship is not worth the paltry money-- which, one could argue, is the case with Greece and Europe. A good way to do it without awkwardness is to offer the debt forgiveness as a "Christmas gift" or "birthday gift". As another example-- if I owed Muammar Gadaffi a large sum of money recently, then I'm relieved that he was overthrown, and now I don't owe him anything any more. Yet again, if I declare bankruptcy, my debts disappear-- this comes with all kinds of bad side effects, but if, as in Greece's case, the debt is too big for me to pay anyway, then it's not a bad move.

    I mean, it's not like it's even mathematically possible for all debts to be paid. If we accept as an axiom that virtually all money in circulation is on loan from somebody (as, e.g., dollars are loaned to the govt by the fed) at non-negligible interest, then the total amount due is quickly larger than the total amount in existence.

    It's always seemed to me that this "You gotta pay your debts" has always been a moral bludgeon used disproportionately on the poor.

    >three generations of economic research

    Oh noes! Reality is failing to conform to three generations(!) of power law assumptions!

  2. @GFM- I should have asserted that it is always expected that one's debt is paid. I'm aware that most lenders expect some level of default on their loans, but that doesn't mean that hey target specific people as prone to default, for they always send out invoices to be paid.

    One thing to keep in mind about aggregate debt is its time component. While there may always be more debt than currency in circulation, this isn't necessarily a problem because not all debts are due simultaneously.