As I prepared for a talk on austerity last week, I found myself a bit stuck. What can you say other than that it’s very clearly not working, nor should we expect it to, nor has it ever? And then I hit upon what I think is the key question: Why do governments stick with the austerity approach when all the evidence suggests it's a total failure?
First, some facts. By austerity I mean attacking recession by cutting spending and raising taxes – the opposite of Keynesianism, which dictates that if the private sector isn't spending enough money to get the economy moving, the government needs to temporarily step in and supply the juice (aka "stimulus"). Europe and the UK are committed to austerity, and – not coincidentally – they've seen growth deteriorate and unemployment jump (to over 20 percent in Greece and Spain). The figure below, from this excellent – and pretty readable – paper by economist Jay Shambaugh reveals the expected positive correlation between governments that cut spending and slower GDP growth.
Too bad for Europe, right? But, wait – we’re doing the austerity thing too, cutting spending as stimulus fades and failing to enact jobs measures, such as fiscal relief to cash-strapped state and local governments or public infrastructure investment – measures that appear more necessary with each new, disappointing economic report.
In a way, our austerity policies are actually less defensible than those in some European countries. With the price of borrowing so extremely low here, capital markets are basically pleading for our government to borrow and get busy with temporary growth measures. That’s not happening in Spain, Italy, Portugal, and Greece, and for good reason: government debt in those countries is highly risky, and priced accordingly.
How is it that policy makers keep getting this so wrong? Sure, there are countries – above all Greece, with its record of government overspending and widespread culture of tax evasion – where some measure of austerity might be in order.
But that doesn’t explain the U.S., the U.K., and most others who continue to blithely go down this bumpy road. For that, I think we need to reflect on what the great economist Joe Stiglitz refers to in his new book on inequality (I recently interviewed Joe for these pages – should be up soon) as deficit fetishism, the prime symptom of which is the inability to distinguish between good and bad deficit spending.
I’ve identified four viruses that have led to this illness:
• For Democrats, deficit reduction was a tactic that morphed into an intractable policy position. Back in the G.W. Bush years, many Democrats (I was one!) argued that cutting taxes as deeply as he did would lead to the bad kind of budget deficits: structural ones that starve government of needed revenues and increase even when the economy is growing. We were right, but too many Democrats now fail to distinguish between structural deficits and Keynesian ones. They just think they’re all bad.
• For Republicans, deficit reduction is a cudgel to bash government. They are ideologically opposed to social insurance, stimulus, infrastructure investment, and everything else, but they gussy this up as an economic argument about markets and debt burdens on future generations. Worse, for them it’s mostly rhetoric. Since Reagan, it’s the Republicans who’ve run structural deficits (Obama’s deficits are largely cyclical—very much a function of the recession).
• Drawing the wrong lessons from the Clinton surpluses: The last time the federal budget was in surplus was at the end of the Clinton years. Economic growth was strong, unemployment very low (below 4% for a few months in 2000!), and financial markets were booming (due, in no small part, to the dot.com bubble, but that’s a different story). These were the years of the alleged bond vigilantes, bond traders who would punish governments by dumping their bonds if they thought their fiscal policy was irresponsible. I’m not sure there ever was such a menace—what led to the late 90s surpluses were a reasonable set of tax rates and strong (albeit bubbly) growth. But whatever…the main point is that fiscal policy during the Clinton years made sense: deficits fell as the recovery gained strength. By no measure does that imply that austerity makes sense in recession.
• In Europe, there’s another dimension to this, something unique to their currency union: anti-bailout sentiment. You think the TARP and the auto bailouts were unpopular here, imagine if they were for Mexico. As a prominent German economist told me, “we know what we have to do, we just can’t let anyone see us doing it.” Good luck with that.
We’d better get straight on all this if we’re going to fix it, not just for this go-round but for the next recession. Imagine arguing for Keynesian jobs measures—another big stimulus—the next time the economy heads south. With all this misunderstanding in the air, there’s just no oxygen for such arguments.
The time for austerity is when the economy is strong and growing. When it’s stuck in the mud, austerity just digs it in deeper.
You can email me at email@example.com. I look forward to your feedback.
Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities. From 2009 to 2011, he was the Chief Economist and Economic Adviser to Vice President Joe Biden, executive director of the White House Task Force on the Middle Class, and a member of President Obama’s economic team.