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The Anti-Economist: The Austerity Myth by Jeff Madrick

The Anti-Economist: The Austerity Myth by Jeff Madrick

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11/05/2012

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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 deicits andcalm inancial markets. Instead, ithas ailed in every country in whichit has been applied. Imposed onnancially 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 bailoutrom the bureaucrats in Frankurtam Main. But despite our weakeconomy, there is no scal stimuluscoming next year, since both Repub-lican and Democratic lawmakers in-sist that the ederal decit 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 sotens 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 budgetdeicits would quickly breed inla-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 inlation—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 difcult cir-cumstances. Sacrifce is the rallyingcry o war, just as asting is a centralpuriying practice o many religions.Sel-sacrifce is also, sad to say, deep-ly attractive as an answer to eco-nomic problems. It
 feels
right—aorm 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 lie, andas vocierous 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. Unortunately, 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. Asor 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 oten cited is astudy by Harvard proessors AlbertoAlesina and Silvia Ardagna, whogathered budget data or major na-tions over a generation and oundthat when deicits ell, periods o economic growth oten ollowed.But deicits oten all or reasonsthat have nothing to do with auster-ity—a sudden boost in tax revenuesrom a stock-market boom, or exam-ple. Economists rom the Interna-tional Monetary Fund, no hotbed o progressivism, switly 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 Stanord 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 ater 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 aected 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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