Dean Baker on the “Growth Through Austerity” argument.

Like a game of wonk whack-a-mole, there’s an argument that says that if we cut the deficit in the middle of a slump and weak recovery we can spur growth.   No matter how much you hit it with a foam rubber mallet of OECD data and white papers, the argument just jumps up through another hole.

Luckily Dean Baker and CEPR swing hard with their new report, The Myth of Expansionary Fiscal Austerity (full pdf here):

Recently governments, economists, and international financial institutions have been debating the merits of further fiscal stimulus to combat the Great Recession versus fiscal austerity or “adjustment” – that is, higher taxes and/or lower government spending – to combat budget deficits. Some supporters of austerity have gone as far as arguing that fiscal adjustment could restore economic growth. These analyses are being touted to oppose increased stimulus to boost the economy. This paper examines the arguments for austerity and demonstrates that current economic conditions in the United States do not support the case for fiscal adjustment.

Baker looks over the type of arguments made by Alberto Alesina and Silvia Ardagna, as well as a new report by Goldman Sachs that makes the same type of argument.   After taking apart their argument and showing how it requires a lot of things to be true for the United States that simply aren’t true, he concludes:

There has been a considerable effort to tout the merits of fiscal austerity as a route to restoring growth. This argument has been put forward in direct opposition to arguments for increased stimulus for boosting the economy. While there may be a case that lower deficits can foster growth under some circumstances, the evidence presented in the Broadbent and Daly paper does not suggest that a movement toward lower deficits in the current economic situation in the United States would be expansionary.

Very few of the countries in which fiscal austerity was associated with more rapid growth adopted austerity at a time when the economy was far below its potential level of output. In none of the cases were they are as far below as the United States is today. In all of the cases where there was a substantial output gap, the country was far more engaged in international trade than the United States. Trade provided a source of demand that cannot have anywhere near as large an impact in the United States at present.

Finally, all the countries that successfully used austerity to boost growth had much higher interest rates than the United States does at present. This meant that there was substantial room for rates to decline following the imposition of austerity.

The differences between the United States in 2010 and the countries that have successfully gone the route of fiscal austerity to boost growth are large and are very central to the adjustment process. In short, in the current economic environment, the circumstances do not exist for fiscal austerity in the United States to lead to more rapid growth. While a quick return to normal levels of unemployment may not be important to those who are primarily dependent on profits or run large corporations, for most of the country, it is essential to their well-being.

What I’ve noticed about this “growth through austerity” argument is that it requires something else to move. 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. There’s a reason economists and governments know to cut during the upswing and not during a weakened state. Dean finds that when you consider the potential level for output it is these types of arguments are even worse.

The IMF went after similar arguments in Will it hurt? Macroeconomic effects of fiscal consolidation (which we talk about here), and Arjun Jayadev and I did the same as well in our working paper The Boom Not The Slump: The Right Time For Austerity. We found that most of these scenario are really countries cutting their deficits during a growth period, which is exactly what you’d expect a rational government to do.

The argument that cutting the deficit right now would make growth happen requires a situation that is the complete opposite of where the United States finds itself; I wish the remaining members of the elite discourse who’d like to convince themselves otherwise would realize this.

This entry was posted in Uncategorized. Bookmark the permalink.

11 Responses to Dean Baker on the “Growth Through Austerity” argument.

  1. Will Ambrosini says:

    You’re misreading A&A’s analysis. They are concerned with the mix of fiscal adjustment not whether or not to adjust. Yes they find that growth follows all type of adjustments but they explicitly say they can’t seperately identify this from the fact that the economy is usually doing well when adjustment occurs. This is why your paper misses it’s mark. And while you criticise A&A for not dealing with this issue, even though they admit they dont and suggest they can’t, you fail to deal with it too. The right interpretation is that we don’t know if adjustments cause growth.

    BTW, in their regressions A&A control for recent growth rates. That’s to say their estimates suggest the positive correlation between adjustments and subsequent growth hold no matter if we’re in a boom or bust. But because we don’t know if this relationship is casual and as your paper points out there’s few instances of adjustments during recessions, we don’t know if this correlation holds in our current circumstance.

    Of course, proponents of adjustment can use the argument of scoundrels: we don’t know if adjustment can work to get us out of recession because it’s never been tried.

    • Mike says:

      ? We find that “their examples of successful consolidation were, on average, growing strongly the year before the year of adjustment.” Do you disagree with this statement, and if not do you think it makes their data set conflicted and distinctly casual and also not-relevant for current policy discussion? If you read A&A’s paper, by the second page they are making the argument for reducing the deficit immediately in the United States, so this is a very targeted argument at elite discussion over budgetary policy and the 2010-11 agenda.

      For the instances from their examples that we find to be closely relevant for the United States currently, when we drill down into the data it show us in a very clear manner that this argument works if you can export out or reduce interest rates, or if you are a small economy. Are these relevant? Do you think private investment is held back by uncertainty over the budget? If not, why are we having this discussion about the research? Is the null hypothesis we must do fiscal adjustment now now now?

      As Arjun mentioned, the jury is going to be back soon on this.

  2. Loxy Bagel says:

    What I would like to know is cui bono? Who gets the cookies if we slash spending and send the economy into the s#!tter? Someone powerful must get some pretty massive benefits if he can convince politicians to take on a course that virtually guarantees they won’t be re-elected.

  3. Arjun says:

    Will,

    Yes, their paper is about mixes in fiscal adjustment or expansion but that has not prevented Alesina himself from making the claim that this is the time to cut-here and elsewhere, based on this work. Their work suggests 26 episodes that they term ‘expansionary adjustments’, and these have been held up, by Alesina as much as anyone else as something which can and should be emulated (a cursory search of Alesina and some interviews shows this, or minimally, that he is misrepresenting the usefulness of his research for the current moment). We note that the filter is at best totally weird, or the nomenclature of expansion is. Our paper is simply an examination of these ‘expansions’ (7 of which, on their own terms should be seen as contractions). If Alesina and others were to say explicitly in their public statements something like ‘Our successes should not be taken as examples of policy adjustments during severe recessions, because they are not”, as you suggest in your final sentence, there would have been no need for our work.

    There are historically and in the last year, examples of countries that have attempted adjustment during a recession-the US in 1937, Ireland since the last year, as well as some Eastern European countries. I don’t think the jury will be out on that for too much longer.

  4. Pingback: Can we cut our way to growth? Internet Related Technologies Can we cut our way to growth?

  5. Pingback: Around The Dial – Oct. 21 | South By North Strategies, Ltd.

  6. Pingback: ginandtacos.com » Blog Archive » AND THEN…

  7. Pingback: Super Link Drop Extreme Edition « The Thread Needler

  8. Dollared says:

    @Loxy, it’s not complicated. If we cut the deficit, then there is no need to allow the Bush tax cuts to lapse. It’s the Great Game of the 21st Century: Bush stole $2T from the taxpayers and gave it to his friends. Obama has allowed the theft to continue, and now every economist who has ever dreamed of owning a second residence in a tropical location is writing papers trying to justify any strategy that will keep taxes low for rich people.

    My father said “No philosopher ever starved himself by writing on the Divine Right of Kings to Rule Absolutely.” Nothing ever changes.

  9. Dollared says:

    PS, thank you Mike. It is a scary world where an endless stream of shameless academics, lobbyists and journalists (never mind Wall Street and the politicians) are willing to support the impoverishment of millions of their fellow citizens so they can make a few extra thousands.

    Thanks for swimming against the tide for the rest of us.

  10. Pingback: 2010-’11: From Austerity to Collapse? « Reflections on a Revolution

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s