The Output Gap Continues; The Impact Of Deficit-Hawks

The difference between "no longer getting worse" and "actually returning to normal":

We stopped getting worse. We still need a serious boost -- like from reversing the austerity of recent budget years -- to get back to good. Alternatively, a large enough boost to EITC could be another way of doing that while at the same time helping mitigate our ever-rising inequality.

Speaking of the recent austerity, here's that in a picture:

Had we not implemented such budget-cutting, deficit-hawk, austerity from 2010 (by not increasing spending commensurate with population growth) and even worse after (by actually reducing government consumption expenditures and gross investment), that alone would have at least had us significantly closer to potential by now. In other words, we'd have had more of a recovery.

If The Policies Were Worse, Explain Why The Outcome Is Better (And Vice Versa)

Timothy Taylor presents a challenge to "critics of the U.S. fiscal and monetary policies in the aftermath of the Great Recession". That challenge: "explain why, if the policies were so bad, the outcome has been comparatively so good."

Turns Out They Weren't All That Concerned With Academic Support

From Jonathan Chait's, "The Arguments of the Great Recession Are Over. Hooray.":

"Academic support for that position has almost entirely collapsed. I don’t even see many conservative intellectuals defending it in columns. And yet the Republican Party marches on, opposing any effort to lift short-term austerity policies that economists almost all believe are holding back the recovery. It’s as if the head of the austerity monster has been sliced off, but the body lurches forward regardless."

Why should this come as any surprise? We're talking about the party that has set itself forward as opposed to the "reality-based community". What use have they for we who "believe that solutions emerge from ... judicious study of discernible reality" when our reality conflicts with their ideology?

The Austerity Crusade Fails Again; If Only They'd Listen To Keynes

It shouldn't have needed yet another proof, but here it is: as John Cassidy puts it, "an official confirmation from the United Kingdom that austerity policies don’t work."

Anybody who works from a knowledge of economic history already knew that. But the high priests of Supply-side were sure. All they needed to do was to be sufficiently faithful to their doctrine. It didn't work. And nobody who even came close to understanding Keynes was surprised by anything other than the deficit-hawks continued belief that balancing the budget will somehow cure all the ails us. Cure it because ... um ... underpants? Surely that's it. The balancing of the budget would cause the confidence fairy's underpants to fit better and she would come dancing along to rain blessings upon us for so dutifully cutting to balance our budgets.

After all, it surely all comes back to underpants, at least when we're dealing with the faith-based economics of Supply-siders (the Trickle-down-istas). For anyone who's seen South Park's "underpants gnomes" and their business plan:

1. Collect underpants
2. ?
3. Profit!

It's the very same with deficit-hawks:

1. Balance the budget
2. ?
3. Profit!

It really does require a pure leap of faith to jump off that cliff. Sadly, there are sharp, pointy rocks below and there really is no confidence fairy waiting around to boost folks back onto solid ground after they slash budgets during a downturn. So march off to the austerity crusade boys. And don't forget to inflict lots of suffering on your economy because that's the only way to scare the evil spirits out of it. Right? We just have to believe hard enough and the confidence fairy will appear. Never mind those rocks. We're not plummeting towards them, they're just growing bigger. That's all.

But no, that's not all. Austerity fails. At least from where we are. Austerity will be harmful so long as we're demand-constrained rather than supply-constrained. And we're clearly demand-constrained rather than supply-constrained. So anyone who was paying attention should have known not to cut spending. But the Supply-side faithful would have nothing of it. Listen? Pay attention to history? Heck no!

Can we please stop with the misguided, ill-timed budget-cutting when our economy isn't roaring along? Pretty please? Austerity fails. Supply-side fails. Trickle-down doesn't trickle down. We can only safely cut when we're already doing well ... preferably when we're overheated. We're not suffering from overabundance. If we bleed our economy of government spending, all that'll do is make the patient more sick. Enough with the "harsh medicine" already. It'll only hurt.

How The Govt Differs From A Household

Another good quip from Krugman in "Losing the Belt",

"When a family tightens its belt it doesn’t put itself out of a job. When a government tightens its belt in a depressed economy, it puts lots of people out of jobs; and this is a negative even from the government’s own, narrowly fiscal point of view, since a shrinking economy means less revenue.

Now, you might argue that slashing government spending doesn’t actually cost jobs — that is, you might argue that if you spent the past few years in a cave or a conservative think tank, cut off from any information about how austerity is working in practice."

That really is a core difference. When a family tightens its belt, it doesn't lower its household income by making one or more family members quit their jobs. When the govt tightens its belt, it pushes people out of work, lowering its own income.

Contraction Leads to Contraction. Go Figure.

Krugman on "What Greece Means": "But what Greek experience actually shows is that ... trying to eliminate deficits once you’re already in trouble is a recipe for depression. ... There is growing evidence that it is self-defeating even in purely fiscal terms ..."

The best way for a nation to pay off large debts is to invest in its future and increase revenue. We say it about businesses all the time, you have to spend money to make money. So why not apply to the gander that which we apply to the goose? Businesses have to spend money to make money. Households that want to increase their income have to spend money to make more money. While there are limits to how much one can reasonably compare a national economy to a household budget, some comparisons do hold: we can't increase our future earnings by slashing government investment in our future earnings.

Yet denying that truth remains popular among our conservatives. Krugman sums up the dangers of listening to them fairly well: "The truth is that if you want to know who is really trying to turn America into Greece ... it’s the people demanding that we emulate Greek-style austerity even though we don’t face Greek-style borrowing constraints, and thereby plunge ourselves into a Greek-style depression."

Cambridge Journal of Economics On Austerity

The Cambridge Journal of Economics special issue for January 2012 covers austerity. One should really at least read the full lead story, "Making the same mistake again—or is this time different?", by Lawrence King, Michael Kitson, Sue Konzelmann, and Frank Wilkinson. A few highlights thereof follow.

"Since the comparative and historical economic evidence strongly supports the Keynesianism over the Treasury view, austerity is not easily interpreted as a rational response to deficits. It is far more explicable as a class project that seeks to roll back the welfare state."

...

"In reality, the historical record provides very little evidence that austerity measures will be effective, particularly in a context of recession. Whilst austerity proponents have argued that the 1920–21 depression in the USA provides confirmation of the positive impact of deflationary policies, Kuehn (2012, this issue) argues that using 1920–21 to justify austerity during a Keynesian downturn is inappropriate because that depression was preceded—and no doubt caused—by austerity. With reference to the current downturn, Pollin (2012, this issue) demonstrates how neoliberal claims—that the 2009 economic stimulus programme in the USA led to rising interest rates and inflation as well as an excessive government debt burden—are unsupported by the facts. Federal government interest payments are, in fact, at near historic lows, and the reason why the stimulus programme did not lead immediately to a strong recovery was because of the severity of the financial crisis and resulting recession, which led to the collapse of household wealth and the seizing up of credit markets for smaller businesses. Further, Taylor et al. (2012, this issue) show that over the last 50 years in the USA, fiscal expansion has repeatedly resulted in higher economic growth, especially during recessions."

...

"Reducing public expenditures during a recession, in contrast, can be expected to increase the national debt as increasing unemployment and falling incomes lower tax revenues and increase social welfare payments."

...

"In the debate about austerity it is important to note that the currently rising fiscal deficits are not a result of increasing entitlement programmes. Rather, they are a consequence of the combined effect of (i) rescue packages to bail out failing financial institutions; (ii) temporary emergency stimulus packages; (iii) global recession (resulting in reduced tax revenues and increased public sector expenditures on automatic stabilisers); and (iv) risk premia on the sovereign debt of weaker countries."

...

"In short, the global economy is stuck in a recession-focussed vicious cycle, which can only be made worse by austerity."

...

"Despite millions remaining jobless and poverty rates rising, governments around the world have claimed that there is no alternative but to impose austerity and cut budget deficits in response to a burgeoning ‘sovereign debt crisis’. ... But austerity is not the only alternative. The world faces deeply structural problems, and the key to recovery lies in encouraging economic growth and moving beyond a single-minded focus on fiscal discipline."

...

"The current financial crisis is the culmination of the progressive freeing-up of the banking sector following the switch from Keynesianism to neoliberalism during the 1970s."

What Can We Really Learn From Estonia?

S&P Downgrade of U.S. and Upgrade of Estonia Inspires Misguided Admiration

In the wake of a few recent S&P decisions, fans of budget cuts are practically waving the Estonian flag. They point to Estonia's recent austerity measures and it's Q1 2011 growth as some sort of vindication. "Look, look ... we've got a positive example!" Ah, but if only it were that simple. There's more to Estonia's austerity and growth than meets the eye of the starve the beast crowd who would have us emulate their example. Estonia chose "internal devaluation," including wage cuts. So keep in mind what following the Estonian script would mean: big wage-cuts and a lower standard of living. Who really wants to sign up for that?

But more importantly, one should take a closer look at the impact on the Estonian economy before declaring them a model that everyone should copy. I'd swallow some short-term pain if it made the overall situation better for my country in the long run. But in the case of Estonia, the trouble didn't entirely end with the turn-around from the -13.9% plummeting GDP in 2009 to the 1.8% growth in 2010 and varying more-or-less positive growth forecasts for their future. While Estonia has returned to GDP growth, they're doing so on the backs of their neighbors. The one bright-spot in their economy is exports, which were up 43% from a year earlier in June. (Although June's figures showed a drop from the previous month.) Their unemployment remains high. Their retail sales and non-govt construction are both still down significantly. The domestic market isn't looking so good there. But in Sweden, Russia, and Finland demand is rising. All three of Estonia's biggest foreign markets saw significantly higher GDP growth in 2010 than Estonia. The strong growth continues in Sweden in particular ... plenty to explain why Estonian producers have still had a market in the face of lower internal demand. Having growing trading partners is great. But in the long run it's a poor substitute for steady internal demand. Estonia's internal devaluation has made them even more dependent on their neighbors. Should the growth in Sweden, Finland, and Russia cease or even slow down significantly, Estonia could find itself in deep trouble with no fuel for its economy. That sort of dependence on -- and vulnerability to -- foreign trade partners has lots of drawbacks. Sacrificing domestic demand to gain foreign demand means a weakened domestic economy.

So what can we really learn from Estonia? Mainly that it's good to have trading partners who have money to spend on what you're making. That's not a lever we (or anyone else) can control. It's up to our trading partners to keep their economies moving. Aside from maybe lending the occasional wrench, we can only look to get our own engine revving again. But we can also learn that worrying too much about increasing our exports can cause a nation to become export dependent -- at the mercy of the whims of foreign markets. While that may be nice when those markets are thriving, do we really want to count on them completely and make ourselves export dependent? Wouldn't you rather we fixed our domestic shortage of demand instead of sacrificing what's left of it in the vague hope for an uncertain boost to exports?

How's that Austerity Going?

Time for an update on how austerity efforts are going.

In Greece, a movement of protesters called Indignados has spread from Spain where signs had taunted, "Quiet, we mustn't waken the Greeks". The effect has reportedly been to transform the previously violent protests into more peaceful protests featuring waving of the Greek flag, much discussion of their situation, and a broad variety of Greeks coming together to reject the Euro plan to shove economy-crushing cuts down their collective throats. In addition to the general protesters, Yannis Palaiologos writes that "more than a dozen of the governing party's deputies are openly expressing their reservations about the new measures, while the main opposition party adamantly refuses to lend its support".

In the U.K., a long list of economics/business profs and other notables wrote a collective letter in the Observer saying, "As economists and academics, we know the breakneck deficit-reduction plan, based largely on spending cuts, is self-defeating even on its own terms. It will probably not manage to close the deficit in the planned time frame and the government's strategy is likely to result in a lot more pain and a lot less gain." They also offered up a rough start of a plan B, though the chances of the Cameron govt accepting their plan B seem low.

In Portugal, Bloomburg reports that "Portugal may have followed Greece into recession even before implementing austerity measures demanded for its European Union bailout that are set to further choke the economic growth needed to tame the country’s debt."

In Ireland, Eamon Quinn reports that, "unemployment has soared from 4.4% in 2007 to 14.8% in May." Their main hope for recovery seems to be an exports boom, although that seems unlikely to overcome the impact of severe austerity measures.

As for Spain, per Sylvia Poggoli, "Under international pressure to cut its deficit, the government imposed sharp austerity measures — cutting public service workers' salaries, freezing pensions and drastically reducing public expenditures. The immediate results: a 20 percent drop in consumption and Europe's highest jobless rate, 21 percent." No wonder they have Indignados.

Cuts Damage: Even for the Body Politic

"For every $1 the government doesn't spend, economic activity shrinks by as much as $2."

from Insights on Stimulus, Thanks to the Mafia

This insight comes from an Italian study showing that when they freeze spending for government project in areas where Mafia corruption was found, the reduction in government spending leads to an even larger decrease in economic activity in the region than the amount of the initial cut. Not only do private sources not step in to make up for whatever the government doesn't spend, but without the government project there is even less private spending than there would be otherwise.

There are, of course, limits to how much the ratios seen in that study will match the ratios one would see elsewhere, such as in the U.K. austerity programs or the massive budget cuts that the GOP is attempting to foist upon the American people. However, the general mechanism will apply. When you're looking at useful infrastructure improvements [roads, rail, bridges, etc.] and/or programs upon which businesses rely for stability -- such as having their healthy, able-to-work labor supply not bogged down with personally looking after their grandparents -- [Social Security, Medicare, etc.], these things will generally hurt economic activity if government significantly cuts spending.

Austerity in Modern History

"Those who cannot remember the past are condemned to repeat it" - George Santayana

On the Dylan Ratigan show, Mark Ames, founder of exiledonline.com, describes what happened in the Weimar Republic when they implemented the measures that the GOP are currently pushing in America::

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"The incoming Republican congress is promising to deliver a megadose of austerity this year and the media and financial elites are telling us we need a major dose of austerity for our own good, whether we like it or not. But what none of the dictionaries or politicians or financial experts are telling us us is that austerity's been tried before -- many times, which might make you think "Oh great, so it's been tried and it works, right?" And that's where things get a little tricky. For example, one of the most infamous austerity programs was tried out in Germany in 1930 by Chancellor Bruning, one of those fiscal responsibility buffs who was sure that the answer to Germany's economic problems was to balance the budget and strengthen the currency by slashing unemployment benefits, pensions, and wages, hiking taxes, and sticking to the gold standard. The result: unemployment exploded, riots in the streets, the collapse of democracy, and the rise of Adolf Hitler. The rest is history. But hey, at least he got that deficit under control."

(Ames also added a further example that he witnessed first hand, the total collapse of the Russian economy in the 1990s after they implemented austerity measures.)

Republicans are fond of referring to the Weimar Republic whenever they're fear-mongering about inflation and advocating the ransacking of our social safety net. What they don't mention -- perhaps cannot remember -- is that the Weimar Republic coped with its inflation and stabilized its currency. It was not their hyperinflation that caused the demise of the Republic by descent into fascism.

Not that inflation was nothing. The hyperinflation was painful. And it was used politically. But the Republic survived the inflation itself, handled the situation, and got on with life after the hyperinflation with a currency that had been mostly stable for years after the reset of 1923/1924 established the Reichsmark. They didn't just achieve stability. The prosperity of the Roaring Twenties ran beyond the United States. In the latter 1920s, Germany also boomed after the hyperinflation under the Weimar Republic.

Then the Great Depression hit, giving the Nazi party more discontent with which to work. Then Chancellor Brüning slashed and burned what remained of the German economy with austerity programs. In theory, austerity was meant to deal with the financial problems of debt and the Great Depression while avoiding a return to inflation. But it was those austerity efforts and their side effects that collapsed the Weimar Republic and the launched Germany into fascism.

Austerity: just painful? Or insane?

"Tensions Rise in Greece as Austerity Measures Backfire"

A glimpse of the future? Those folks screaming for focus on deficit reduction -- massive budget cuts -- if they succeed, they may be sending us down the path that Greece is currently taking into the abyss. Austerity is dangerous, especially in a slow economy.

"In Ireland, a Picture of the High Cost of Austerity"

Ireland, Greece, ... the other side of the Atlantic is giving us plenty of dire example for what can happen when you focus on deficit reduction while your economy is running slow. In slow times, cuts may take away what little demand there is ... which means less payroll tax income ... which can mean bigger deficits. Ironic, eh?

Update 01/06/2011:

Germany has joined the club of pain and protests have started there.

UK: UK labor unions warn of surge in strikes

Italy: Italian students are protecting austerity measures. The NY Times reports, "Giuliano Amato, an economist and former Italian prime minister, was even more blunt. “By now, only a few people refuse to understand that youth protests aren’t a protest against the university reform, but against a general situation in which the older generations have eaten the future of the younger ones,” he recently told Corriere della Sera, Italy’s largest newspaper."

Spain: "New austerity measures in Spain, where the overall unemployment rate is 20 percent, the highest in the European Union, are further narrowing the employment window. Spain has pledged to raise its retirement age to 67 from 65, but incrementally over the next 20 years."

All because they're embracing austerity rather than splitting up the currency and having the struggling economies apply the medicine they really need.