The Corner

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Breaking the Rules on Austerity


In 1925, John Maynard Keynes wrote a desperate plea for economic common sense over rigid orthodoxy entitled “The Economic Consequences of Mr. Churchill.” The patron saint of today’s progressive economic-policy wing would be appalled at his economic legacy’s being invoked to defend a comparable dangerous rigidity. 

After all, the numbers say that the Keynesian playbook has been run to perfection. In 2009, when the “GDP gap” (the amount of slack between potential GDP and the actual level) was $1.011 trillion, the change in the full-employment deficit – the gold-standard measure of fiscal stimulus in a Keynesian model – was $649 billion. Even with a fiscal multiplier as low as 1.6, GDP should have reverted to full capacity and the problem should have been solved. (If one allows for lags and looks over the longer 2007–2009 period, the stimulus was even larger.)

The problem wasn’t solved. And it stayed unsolved through modest tightening and loosening in subsequent years. Still, the perennial calls for stimulus continued. What was guaranteed to work on whiteboards in classrooms, the rosy musings of progressive thinkers, could not possibly fail in the real world. Except it did.

The consequences are plain enough to see, and equally unappealing to those of all political and economic stripes. As described by the chief polemicist for progressive policies, Paul Krugman:

Now, some unemployment is inevitable in an ever-changing economy. Modern America tends to have an unemployment rate of 5 percent or more even in good times. In these good times, however, spells of unemployment are typically brief. Back in 2007 there were about seven million unemployed Americans — but only a small fraction of this total, around 1.2 million, had been out of work more than six months.

Then financial crisis struck, leading to a terrifying economic plunge followed by a weak recovery. Five years after the crisis, unemployment remains elevated, with almost 12 million Americans out of work. But what’s really striking is the huge number of long-term unemployed, with 4.6 million unemployed more than six months and more than three million who have been jobless for a year or more. Oh, and these numbers don’t count those who have given up looking for work because there are no jobs to be found.

Exactly. And sadly, the only self-critique progressives can offer for their failed, interventionist, Keynesian policy regime is that it wasn’t big enough or that “austerity” economics choked its success.

As we’ve seen, the stimulus was plenty big enough, but that won’t satisfy those with such a rigid mindset. After all, when the policy fails, they can always say it wasn’t big enough. The framework simply does not allow for any other possibility. 

In order to distract from the dismal state of analytic and actual economic affairs, the latest tactic is to blame “austerity economics,” personified by two researchers, Carmen Reinhardt and Kenneth Rogoff, who made the reasonable observation that ever-larger amounts of debt must eventually be associated with bad economic news. Never mind that the numbers say there has been no austerity implemented in Europe or here, so it’s hard to understand what they’ve being blamed for. It is still more humorous to hear the cacophonous claims that there is no absolute trigger holding that, when debt reaches 90 percent of GDP, growth will slow by one percentage point.

Of course not. Economics simply does not provide that kind of precision – something that progressives, with their output gaps, full-employment deficits, and multipliers, might want to ponder if they find a rare moment of humility. You can torture the data and not find any support for the notion that high debt-to-GDP ratios are a good idea and associated with faster growth. And you can find substantial support for the opposite.

The reality is that the financial crisis was an enormous wealth shock, as values in housing and financial assets collapsed. The Fed did its part to counter the downdraft by lowering interest rates (which raises asset values) and otherwise supporting financial markets. But fiscal policy went exactly the wrong direction, focusing on higher taxes on saving, investment, and wealth. The president pursued a relentless politics of envy against the affluent, implicitly demonized wealth itself, and left a paucity of job-creating – but wealth-pursuing – business startups.

Progressives are now trapped by their rigidity and politics. The U.S. needs a pro-growth tax code, but the “rules” do not permit lower rates and rewards to saving, investment, and growth. The U.S. needs reform of its health-care and pension entitlements, but the “rules” say austerity is bad. The U.S. needs a future with less debt, but the “rules” say that more debt is good. 

It is time to toss out the progressive rulebook — and the economic consequences of progressive economics.