A
s economic adversity contin-ues to spread, rom Athens to Ma-drid, London to the Beltway, austeri-ty has become a most dangerousidea. What now dominates the worldis the popular theory that i coun-tries just tighten their belts, stronggrowth and lower unemploymentwill soon ollow. It is the opposite o the Keynesian lessons learned romthe Great Depression and is support-ed by neither historical nor empiricalevidence. The world’s leading eco-nomic commentators, Nobel Laure-ate Paul Krugman o the
New YorkTimes
and Martin Wol o the
Finan-cial Times,
have regularly railedagainst austerity, but to little avail.Advocates o austerity in WesternEurope have claimed that it wouldrapidly reduce budget deicits andcalm inancial markets. Instead, ithas ailed in every country in whichit has been applied. Imposed onnancially shaky European nationsby their more robust partners, par-ticularly Germany, it is largely re-sponsible or unemployment ratesapproaching 25 percent in Spainand Greece, which was the levelreached in America during theGreat Depression. In Portugal andIreland, unemployment stands atroughly 15 percent. And in the eurozone, much o which is now in a ull-fedged recession, the average rate o joblessness is 11 percent—the high-est since the monetary union wascreated in 1999.The United States, too, has beenattracted to austerity or some time.We are not, it’s true, obliged to slashbudgets in order to obtain a bailoutrom the bureaucrats in Frankurtam Main. But despite our weakeconomy, there is no scal stimuluscoming next year, since both Repub-lican and Democratic lawmakers in-sist that the ederal decit is the na-tion’s most urgent problem. In act,ederal as well as state and localspending has been alling or a year ormore, and i we go over the “iscalcli” o automatic spending cutsmandated by the 2011 budget com-promise and the expiration o theBush tax cuts, government stimuluswill shrink much urther. Even i Washington sotens the blow by post-poning or reversing tax and spendingchanges, government will suck hun-dreds o billions o dollarsout o the economy.
I
there is a central idea behindausterity economics, it is the de-bunked pre-Depression assumptionthat economies are sel-adjusting. Asincomes all and borrowing declines,goes the argument, interest rates alsocome down, encouraging business toborrow and invest again. And in arecession, o course, prices may alsocome down, so consumers will startbuying again. The inancial estab-lishment o the early 1930s, led byRepublican treasury secretary An-drew Mellon, was content to sit tightand allow the economy to recover onits own. Mellon eared that a stimu-lus package and its resulting budgetdeicits would quickly breed inla-tion, drive up interest rates, and ruinwhatever halting progress had al-ready been made.Today the heirs to Andrew Mel-lon imagine infation to be aroundevery corner. John Maynard Keynesthought he had rid the world o thisdestructive idea with his classic 1936study,
The General Theory of Em- ployment, Interest and Money.
Notso. John Cochrane, an outspokeneconomist at the University o Chi-cago who has characterized Keynes-ian scal stimulus as “insane,” pro-claimed in early 2009 that thegreatest danger to America would behigh inlation—unleashed, o course, by such big-spending ederalpolicies as President Obama’s $787billion stimulus package. The ubiq-uitous economic historian Niall Fer-guson, now o Harvard, orecast asimilarly deleterious increase in in-terest rates. (Even with both infa-tion and U.S. interest rates at negli-gible levels today, neither Cochranenor Ferguson has recanted.) Mean-while, such Mellonites as the ante-diluvian Jens Weidmann, the cur-rent head o the German centralbank, stubbornly repeat the samewarnings to European policymakers.How, you may ask, did we gethere? To appreciate the hold austeri-ty has on otherwise intelligent
the AntI-economIst
The Austerity Myth
By Jeff Madrick
THE ANTI-ECONOMIST 11
Jeff Madrick is a senior fellow at the Roose-velt Institute and the author, most recently,of
Age o Greed.
economists, we must understandthat it is as much a superstition asan economic theory. Like all super-stitions, its roots are deep in humannature. Sel-denial, rom the
Odyssey
to the Old Testament, has been atraditional reaction to difcult cir-cumstances. Sacrifce is the rallyingcry o war, just as asting is a centralpuriying practice o many religions.Sel-sacrifce is also, sad to say, deep-ly attractive as an answer to eco-nomic problems. It
feels
right—aorm o penitence and machismo.Perhaps that’s why Spain andGreece have voted in austerity re-gimes, even at the cost o ruiningtheir economies and civic lie, andas vocierous anti-austerity minori-ties in those countries grow louderand more anguished.The problem is that although aus-terity may work or individuals, it sel-dom works or economies. To thecontrary, requently it makes mattersworse. I all individuals tighten theirbelts, demand or goods and serviceswill all, workers will be fred, anddemand will all even more. Businesswon’t invest without growing sales:this was Keynes’s message in a nut-shell. He argued that governmenthad to supply the spending or goodsand services that would restore in-centives to invest, while simultane-ously lowering interest rates. Ratherthan adjusting down, unemploymentcould stay high indefnitely.The depression o the 1930sshould have disabused economistso the belie in the sel-adjustingpropensities o ree-market econo-mies. Unortunately, the theory hasbeen resurrected in major Americanand British universities over thepast generation. Not only is stimu-lus not really necessary, these aca-demics assert; it won’t work. Theyargue that more government stimu-lus won’t lead to spending by con-sumers, who instead will save theirmoney because they realize taxeswill eventually be raised to fnancethe debt. They also argue that anincreased ederal defcit will crowdout private borrowing and produc-tive investment, and eventually jackup interest rates. In other words,government spending will have lit-tle or no bang or its buck.This theory is mostly baloney, es-pecially during economically weakperiods. I Americans are given mon-ey now, they will certainly spend it—or at least work down their debt. Asor interest rates, they are at recordlows today, despite highbudget defcits.
N
eedless to say, austerity econ-omists claim they have the evidenceto support their views. Yet their re-search is shoddy and transparentlymisleading. Most oten cited is astudy by Harvard proessors AlbertoAlesina and Silvia Ardagna, whogathered budget data or major na-tions over a generation and oundthat when deicits ell, periods o economic growth oten ollowed.But deicits oten all or reasonsthat have nothing to do with auster-ity—a sudden boost in tax revenuesrom a stock-market boom, or exam-ple. Economists rom the Interna-tional Monetary Fund, no hotbed o progressivism, switly challengedAlesina’s and Ardagna’s work. Theiranalysis o the historical data, ocus-ing on occasions when governmentsmade deliberate austerity decisionsto cut defcits, ound that in almostall such cases, unemployment roseand growth slowed—just as is hap-pening today.Another popular but dubiousfnding is that public debt o 90 per-cent o GDP or more seriously im-pedes economic growth. This wasthe argument made by Kenneth Ro-go and Carmen Reinhart, authorso the acclaimed book
This Time IsDifferent.
But their analysis is high-ly distorted by the soaring U.S. def-cit during World War II, which theylumped together with other data toprove that such high debt leads toslow growth or to recession. Whenthe war ended, the United Statesindeed ell into steep recession, butthe decline was due to the end o intensive war production, not thehigh defcit.Then there is John Taylor, a vet-eran economist rom Stanord and amember o George H. W. Bush’sCouncil o Economic Advisers, whowas among the most vocal critics o the Obama stimulus in 2009. Taylorbased his view on a simple paper hehad written in which he showedthat Bush’s 2008 tax rebate o about$100 billion was not spent by con-sumers. Flat consumer spending, heargued, means no growth. But
Christina
Romer, a Berkeley econo-mist and ormer chair o Obama’sCEA, pointed out that consumptionshould have allen at the same timebecause house prices were collaps-ing; that it held steady showed therebate had worked.The advocates o Keynesianstimulus have built a stronger, morecomprehensive empirical case intheir avor than have proponents o austerity. The economy had alleno a cli when Obama was electedin 2008: Americans were losingjobs by the hundreds o thousands,and GDP was plummeting. But bythe third quarter o 2009, a ewmonths ater the stimulus beganreaching Americans, the ree allhad stopped. More detailed analysisbacks up this conclusion. For exam-ple, measuring the impact o thestimulus on state spending showslocal improvements in growth. Rea-sonable estimates are that the stim-ulus created 3 million jobs in itsfrst year.Why, then, didn’t the economycontinue to grow rapidly? Austerityadvocates have claimed that persis-tent high unemployment is proo that the stimulus ailed. The stimu-lus, in act, was too small whenmeasured against the depth o therecession. A second stimulus wasnecessary, but by then even theDemocrats had been seduced byausterity economics and set out tochop away at the defcit.There is considerably more evi-dence o the benefts o fscal stimu-lus. Researchers have looked stateby state at how military spendinghas aected local growth and ounda close correlation between moregrowth and higher government ex-penditure. (In a classic example o hypocrisy, Republicans themselvesare now demanding that militaryspending not be cut because it willcost jobs.) Other researchers haveshown similar improvements ingrowth and employment in reactionto higher levels o local Medicaidspending. Still others fnd that the
12 HARPER’S MAGAZINE / OCTOBER 2012
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