Dayen, CRS, Bernstein on the Myth of Expansionary Austerity

David Dayen has an excellent catch-up in the American Prospect on where Washington is on short-term stimulus versus deficit cutting/austerity in the debt ceiling battle:

One only needs to look to Britain, which cut $180 billion from its budget last year, to preview the disastrous effects of such a cut. The economyshrank, and real household income dipped to its lowest level since the 1930s. “There’s no way that budget cuts are not going to slow down the growth of the economy,” said EPI’s Mishel….

Republicans theorize that a deficit deal would increase confidence in the business sector and financial markets, spurring economic growth all by itself. But there’s ample reason to suspect this ”expanding by contracting” theory. Sadly, the Obama Administration appears to have swallowed it. Last week, several White House officials, including Director of the National Economic Council Gene Sperling, stressed deficit reduction as the primary component of their economic-growth strategy, and repeatedly claimed that reducing the deficit would generate “confidence.”…

“I think it’s bogus,” said Mishel, of EPI. “And it reflects what happened in the Clinton era, when you elevate a tactic to the level of principle. They feel politically forced into shifting to deficit reduction. And they now rationalize this as good for jobs. And I think they all know better.”

That last quote about the rationalization of tactics into principle is perfect.  Check it all out.

Someone noted that with Goolsbee leaving, all of the big names surrounding economic policy are no longer economists but lawyers and people associated with Wall Street.  And it is also telling that, with the Larry Summers editorial from the weekend, all of the economists you’d recognize who have left the administration are calling for more stimulus, while it is those there now calling for confidence.

It’s tough for me to see a difference between “expansionary austerity” and what we are hearing about restoring confidence as the next step to a healthy economy from the administration.  We went through some of the intellectual history of the argument, one starting with a study by Alberto Alesina of Harvard, that cutting the deficit will lead to growth here.

Since then, the Congressional Research Services went through that Alesina study that argued for expansionary austerity, the same study that England used to justify its disastrous cuts, and found an interesting result.  Jared Bernstein summarizes the results:

Based on international evidence, AA claimed to find that “expansionary fiscal adjustments”—episodes of deficit reduction that led to growth—were largely driven by spending cuts.  As you can imagine, this has a lot of conservatives in a deep swoon.  Combine it with the Laffer Curve, and you’ve got the R’s complete toolkit: cut taxes to gain revenue; cut spending to boost growth.

But alas, it doesn’t work.  As can be seen from the CRS figure below, there is something quite unique in AA’s examples of “successful” fiscal adjustments.   Period T-1 is the year before the adjustment (deficit reduction) and period T is the year in which it took place.

What the figure shows is that the countries in the AA study deemed successful–where spending-based deficit reduction led to growth–lowered their deficits when their economies were pretty much back to full strength.  The second bar (“all unsuccessful”) shows that if you tried deficit reduction when you were below full strength, it hurt your growth.

And—drum roll please—even those unsuccessful adjustment were made in conditions FAR BETTER than where the US economy is right now.  (See fourth bar in both panels; ignore the third bars).

A fantastic study with a great writeup.  As Arjun Jayadev and I found when we went through Alesina’s examples, you can cut your way out of a recession as long as you can lower interest rates. Or export your way out of the recession. Or if you are comfortable blowing up your debt-to-GDP ratio. Or if you let unemployment skyrocket further. Or if you are a really small country. The big two are interest rates and exports, and neither are available at the zero bound or in a global recession. And without being able to put this in motion an austerity measure would be very, very ugly. We found that there is no episode in which a country facing the same circumstances as the United States (recent recession, low interest rates, high unemployment) has cut its deficit and succeeded in reducing its debt through growth.

There’s a reason economists and governments know to cut during the upswing and not during a weakened state.  Or at least, they used to know.

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7 Responses to Dayen, CRS, Bernstein on the Myth of Expansionary Austerity

  1. kleptco says:

    It’s like if I have TB and I’m fat and the doctor tells me to first lose weight.

  2. LosGatosCA says:

    It’s depressing day after day to read about such obviously bad policy proposals that have no empirical evidence to support them. The policies are bad enough, but the fact that they even have to be refuted is the depressing part. That these same shills have been using the same unsupported assertions in the mainstream for the past 11 years without any damage or even fear of damage to their professional reputations is very sad.

  3. Pingback: I Ruined The Economy And All I Got Were These Lousy Tax Cuts - NYTimes.com

  4. Luis Enrique says:

    “real household income dipped to its lowest level since the 1930s”

    um, what? the income of households in terms of goods and services fell below that of the 1930s?

  5. El Cid says:

    They don’t care whether it’s “true” or not. The deficit fetish is there to *convince* ordinary people of a reason to cut spending they don’t like and cut taxes etc. on the rich and especially super-rich they do care about.

    It works, too. People I work with are convinced that the reason the economy is weak because of ‘all the spending’, and if only we didn’t have so much of a deficit, things would get better.

    I try to ask questions like “If the deficit vanished tomorrow and all else remained exactly the same, how would your friends and relatives get jobs back, or better pay?”, or “When do you think this business has made its decisions on what to do based on ‘the deficit’ and ignored things like supply, demand, returns and such?”

    That Cheney quote about “Reagan proved deficits don’t matter” is COMPLETELY MISINTERPRETED, all the time.

    Cheney wasn’t talking about some economic theory. You think he gave a sh*t? No, he meant deficits *DON’T HARM REPUBLICANS ELECTORALLY*.

    Bush Jr.’s regime and the conservative movement argued that the Clinton surplus was *immoral*.

    If you have a surplus, they said, it meant you took too much money from people and therefore had to return it.

    So we can’t have a rational discussion about the revenue side of the budget, because, in essence, collecting tax revenues in general is thievery, and who needs revenues anyway? A budget with inputs and outlays is just sooooo outmoded. Nowadays we know that budgets are made purely by attention to spending, and only spending on programs designed on aiding the population.

  6. Pingback: Obama And The Economy: Going The Way Of The Timid « The Erstwhile Conservative: A Blog of Repentance

  7. phil melnik says:

    So in the end there is no way out it seems except for a painful unwinding is the message I get

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