From the comments

by on June 9, 2010 at 12:12 pm in Economics, History | Permalink

…in 1981 Margaret Thatcher cut UK government spending in the middle of a recession, and against the advice of 391 economists that it would worsen the recession, and UK GDP started its recovery the same quarter. In 1991 Ruth Richardson in NZ cut government spending against the advice of 15 economists, and NZ GDP started its recovery the same quarter. There are a number of other cases of expansionary fiscal consolidations, and there's a causal theory to explain why this can happen – see http://ideas.repec.org/p/cpr/ceprdp/417.html (shortly, it's that cutting government spending improves people's expectations about the future of the economy and taxes, so they start investing more right now). Of course, correlation does not prove causation, and perhaps there is something about the EU countries now that is so different as to the cases I cite as to make those results no longer likely to hold, but Krugman writes as if he has forgotten entirely about the 1980s and 1990s.

That is by TracyW.  Later in the thread she refers us to this paper, on how "contractionary" fiscal policy can be expansionary, and vice versa.

Doc Merlin June 9, 2010 at 12:24 pm

The same thing happened in the US in the 1920 recession. We had a massively steep recession, the federal government tightened fiscally and things quickly improved.

TheophileEscargot June 9, 2010 at 12:29 pm

The thing about the early Eighties cuts from the Thatcher government in the UK, was at the same time they liberalized the tight rules on credit cards and personal finance. So the fall in government spending was compensated for by a sudden rise in private borrowing-and-spending from credit cards, loands and remortgages.

But these days, private consumers are already carrying high levels of personal debt. We probably don’t have a huge pent-up demand for more private borrowing. So it’s unlikely to play out the same way this time.

Tom June 9, 2010 at 12:35 pm

This doesn’t make any sense. Adn Thatcher’s government proved monetarism didn’t work–not hte way Friedman thought it did. I think Krugman is capable of debunking this one pretty easily –or Delong.

babar June 9, 2010 at 12:45 pm

what were inflation rates when these were done? were there other measures to loosen money besides govt spending? did unemployment rates shoot up and for how long?

JasonL June 9, 2010 at 12:58 pm

Bottom line – macro economics is witchcraft.

Travers June 9, 2010 at 1:32 pm

In the NZ and Thatcher case, they did a lot more than “pare back”. They also massively deregulated their economy and, in NZ’s case, pretty much got rid of a lot of their protectionist trade policies.

Thatcher’s “revolution” was disinvesting from bad government expenditures: keeping open coal mines that did not make a profit, breaking the back of trade labour unions that stifled employment, etc.

If we are comparing them with the US, then the US would have to do the following:

* Kill the Farm Bill
* Remove almost all restraints of trade legislation (for my fellow lefties, a lot of that legislation was written by and for corporate interests, so they weren’t actually protecting society or people)
* Drop all trade barriers
* Shut down all supports for private enterprise: no more subsidies, tax credits, tax shelters, etc.
* Introduce a VAT (which NZ did, and which Thatcher raised)

Do you think THAT’s the kind of “restraint” we will see?

Greg Ransom June 9, 2010 at 1:36 pm

Australia cut spending in the early years of the “Great Depression” — and avoided one.

Justin June 9, 2010 at 1:51 pm

@Greg – they were also one of the first to abandon the gold standard.

Miguel Madeira June 9, 2010 at 1:58 pm

“in 1981 Margaret Thatcher cut UK government spending in the middle of a recession, ”

According to this, Thatcher only cut government spending at one year (88/89):

http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2010/06/thatchers-axe.html

Weeksie June 9, 2010 at 2:04 pm

@Greg

I could be remembering my history wrong but Australia had a much worse time than most other countries during the Great Depression and their recovery was slower. Where did you hear that we recovered faster?

Right Wing-Nut June 9, 2010 at 2:13 pm

Does FDR’s 40% devaluation of the dollar count as going off gold or not?

I have a hard time seeing the politicization of money as a good thing under any circumstance. Government already had too many ways to rob people blind.

Andrew June 9, 2010 at 2:26 pm

In the 1980s and 1990s the problems in Europe were concentrated in the north rather than the south although Greece was there too.

I think that you could add;

Sweden (1983 and 1993)
Finland (1983)
Greece (1989)
Belgium (1982)

These countries (along with Denmark and Ireland as cited in the referenced paper) had a median size of budget adjustment (as a % of GDP) of 13.6%.

The median length of time was 7 years.

The median real GDP growth rate before adjustment (5 year CAGR) was 1.4%.

The median real GDP growth rate after adjustment (5 year CAGR) was 2.8%.

The median difference was +1.4%.

The median five year change in government revenue (% of GDP) was -0.8%.

The median five year change in government spending (% of revenue) was -5.8%.

These are all real life examples of countries that cut spending and began to grow faster.

Brian J June 9, 2010 at 2:52 pm

Exactly what sort of spending was cut? Was it short-term spending, or was it long-term spending obligations on things like health care? If it’s the latter, it would make sense, and it wouldn’t be completely out of line with what people like Brad DeLong and Paul Krugman are arguing: that we need to get things like health care spending under control for future decades but don’t need to worry nearly as much about current deficits.

Greg Ransom June 9, 2010 at 2:57 pm

Another smart move.

“@Greg – they were also one of the first to abandon the gold standard.”

aaron June 9, 2010 at 4:04 pm

If you can get a low interest loan, it makes sense to pay off the 20% interest credit card before you take out a loan to buy gas for the sports car you bought with the 20% interest credit card.

The government needs to pass its low rate on to people with existing mortgages before it throws money on the bonfire.

Andrew June 9, 2010 at 4:32 pm

First there is the question whether “aggregate demand” is anything more than a number.

If it is more than a number, it probably isn’t increased or decreased just by juicing the number. It’s about sentiment.

If it is about sentiment, then if increasing the number decreases sentiment, then it could be shown that increasing “aggredate demand” could reduce “aggregate demand.”

spencer June 9, 2010 at 4:56 pm

Anoymous — it depends on which example of Japan you look at.

But they had cases where they were getting a recovery going and tightened monetary and/or fiscal policy and killed the expansion.

For the most part Federal Reserve officials blame the Japanese lost decade on policy mistakes and believe the US can avoid making similar errors.

Hopefully, such confidence is justified.

But remember, the Japanese lost decade was not an “L”. Rather it was a series of mini-cycles, each with its own characteristics.

Gabe June 9, 2010 at 5:25 pm

There is no point in arguing Yancey.

The absolute faith dispalyed by the Aggregate Demand Fetishist will never be broken until the fundamentalist sect of Keynsian/monetary central planners can has made things so bad that the people force the return of sane economic policies.

Steko June 9, 2010 at 5:51 pm

On Australia and the “Great Depression”…. Do your own research.”

The facts appear to refute your ideas that (1) Australia never experienced depression and (2) cutting spending was the key to recovery. Of course facts and Austrian economics have never really gotten along well.

http://en.wikipedia.org/wiki/Great_Depression_in_Australia

A five year unemployment average for 1930-34 was 23.4%,with a peak of 28% of the nation being unemployed in 1932. This was one of the most severe unemployment rates in the industrialised world, exceeded only by Germany.

… in [1930], all state and federal governments agreed to slash government spending, cancel public works, cut public service salaries and decrease welfare benefits…

The Labor Party soon split into three separate factions… Joseph Lyons, led a conservative faction, which believed in classical economic policy … Lyons won this election in a landslide.

Before being voted out of office, the Scullin government had introduced a law, the Financial Agreement Enforcement Act 1931 to force [adherence to] debt commitments…

1932-1939: A slow recovery

The devaluation of the Australian pound, abandonment of the Gold Standard, recovery of major trading partners like the United Kingdom and public works projects instituted by State and local governments led to a slow recovery. Unemployment, which peaked at 29% in 1932, was 11% at the start of the Second World War.

Yancey Ward June 9, 2010 at 6:30 pm

Bill,

I would just like the see the evidence that favors increasingly large stimuli from government spending.

sammy June 9, 2010 at 7:54 pm

You cite two instances? A sample size of two countries in only a couple of decades to prove your point?

Bill June 9, 2010 at 9:20 pm

Yancey,

You asked to “see the evidence that favors increasingly large stimuli from government spending.”

Here is the CBO report on the effect of the stimulus program: http://www.cbo.gov/publications/collections/collections.cfm?collect=12

mulp June 9, 2010 at 10:17 pm

“…in 1981 Margaret Thatcher cut UK government spending in the middle of a recession”

Make me think of the Clintonism on meaning of is, what is meant by cutting spending?

Looking at a wikipedia chart on Thatcher, I see it reflects the kinds of increases in spending I would like to see in the next decade here in the US:
GDP and public spending
by functional classification % change in real terms
1979/80 to 1989/90[68]
GDP +23.3
Total government spending +12.9
Law and order +53.3
Employment and training +33.3
Health +31.8
Social security +31.8
Transport -5.8
Trade and industry -38.2
Housing -67.0
Defence -3.3

I’m not so hot on increasing policing, but I support increasing job training, health care, and SS spending faster than growth in economy.

Of course, the US government doesn’t have a big ownership of housing, nor of industry. We can’t sell off the profitable BP or an unprofitable ship building. BP didn’t change much, but while Maggie refused to accept Britannia no longer Ruling the Waves, she shutdown the UK shipbuilding and effectively removed the UK from the shipping industry, the industry that made the UK great. Not to mention creating lots of unemployed, so the workers in the shipbuilding industry and coal mining remained in many case on the government payroll.

I also find it odd that the response to Obama policies not reducing employment is to adopt Thatcher policies which increased unemployment. It seems like the idea is, “hey unemployment is already high, let’s make it higher so we can blame Obama for the high unemployment.”

Like Carter is blamed for the high unemployment during the second year of Reagan’s term, conveniently omitting the employment increase until Reagan’s tax cuts were passed, when they turned down and fell for 18 months….

Fiscal responsibility is not supported by the voters, especially Republicans – Clinton made sure the budget improved during his entire term even as Congressional Republicans fought to increase the deficit, but were blocked by Clinton.

The best case for limiting/cutting government spending to produce growth is the Clinton years, but that is not acceptable to those in favor of cutting government because Clinton got support for cutting spending growth by increasing taxes. Republicans gain support for cutting taxes by increasing spending, because conservatives want increased spending as much as liberals.

Ian June 9, 2010 at 11:45 pm

Closer to home.
Apologies for my vagueness about this, but didn’t George Herbert Walker Bush reduce the deficit by a combination of tax increases (breaking his read my lips pledge) and spending cuts — setting the scene for the boom years of the 1990s?

Greg Ransom June 10, 2010 at 2:48 am

Steko, you lie like a rug. I said neither thing:

“The facts appear to refute your ideas that (1) Australia never experienced depression and (2) cutting spending was the key to recovery.”

Constrast the US and Australia in 1938 — what makes the American depression “Great” it’s relative length and continued size. You don’t call the massive US depression of 1920 a “Great” depression because things got progressively better. They did in Australia as well. They didn’t in the US.

Al Brown June 10, 2010 at 5:20 am

If we want to do something about unemployment, do away with the minimum wage and simultaneously cut taxes on low wage workers in such a way that roughly compensates.

When prices for a product or service are held too high, demand is certainly curtailed. That’s bad news for the lowest quality suppliers. For example, if all cars now had a minimum price of $50K, car makers focused on the low end of the market are screwed. The market will be buying fewer cars and the low end will suffer most.

This is precisely the problem with labor market in many countries right now. Minimum wage laws are keeping wages on the low end higher than buyers are willing to pay. Buyers were willing to pay those prices when the housing bubble was distorting demand for labor, but that’s all over now.

These workers would like to sell their labor, but its too expensive for employers.

What can be done without unnecessarily hurting the workers making the least? Two things. First, eliminate the minimum wage. And, at the same time, cut taxes on those who make below the minimum wage, enough to compensate for any loss.

These actions will make low end workers more attractive to hire and enable employers to compete in the global market place.

Tax revenues will decline, but so will unemployment insurance costs and government job creation expenses. And we’ll help people keep working at real jobs.

Andrew June 10, 2010 at 6:01 am

Don’t forget this part, Bill.

‘Advancing a theme he has emphasized in the last few months, Mr. Bernanke said that if Congress pursued more fiscal stimulus to sustain the recovery, it should be accompanied by a concrete plan to bring the deficit back into line in the long run. Without a fiscal “exit strategy,” he said, the U.S. could, “in the worst case,” see financial instability like in Greece.’

“We have a recovery under way now. So, in the very near term, increased taxes, cuts in spending that are too large would be a negative, would be a drag on the recovery,” Mr. Bernanke said. “At the same time, we need to convince markets that in the medium and longer term we have a sustainable fiscal path.”

I think the “genius” of Tim Geithner, and this is only a half-back-handed compliment is he didn’t really come out strongly on anything. Remember when everyone was dissing his plan for a lack of details? Looks like genius now.

The government can just say we are going to keep chugging along while remaining cautious. Nothing too fancy. That’s what Bernanke just did.

Yancey Ward June 10, 2010 at 10:57 am

Bill,

So, what you are saying is that the stimulus was predicted by those same people to keep unemployment from exceeding 8%, but when it reached 10% the same people claim the stimulus helped keep unemployment from exceeding 10%- so far. Great! We can just, after the fact, claim the stimulus did whatever we want to claim the stimulus did. This is essentially an unfalsifiable argument.

Steko,

Same damned thing. If government pays people to build stuff and sink it in the ocean, does that count as economic growth? Why don’t you look at consumer consumption levels 1929 to 1945? Then look at those levels post 1945 when government spending greatly decreased. That is the real measure of economic growth and vitality. No is denying that government can employ any number of people and get whatever level of “unemployment” it desires, but if those people aren’t actually producing goods that people desire and consume, or producing the goods that produce the goods that people desire and consume, then it is a waste in a true sense.

JasonL June 10, 2010 at 11:12 am

Request of marginal revolutionaries: I could use some help understanding the various arguments about how our situation connects to the Japanese Lost Decade. DeLong keeps saying that’s where we’ll wind up if we don’t spend, but my understanding is that the Japanese spent and spent some more on public works projects (boondoggles?). I don’t see any connection, but I’m not a professional economist either.

TracyW June 10, 2010 at 12:22 pm

TheophileEscargot – I agree that it’s probably unlikely to play out the same way this time. On the other hand, nowadays we face a darker fiscal future, with the baby boomers starting to retire and government health spending already far larger as a share of GDP and rising sharply (I’m not just talking about the USA, but about all the Western countries), so expectations of future tax rises should be substantially larger too.

Colin – I’m not wedded to any macro-economic theory, my macroeconomics courses covered a lot of theoretical explanations of business cycles and the main conclusion I came to was that I could see no reasons why diffferent recessions and recoveries couldn’t have different causes.

Miguel Madeira – you’re right, it was a rise in taxes, not a cut in spending. My mistake. I must remember this in the future.

Travers – In the case of NZ, much of the major deregulation happened under Roger Douglas from 1984-1988. Ruth Richardson’s government did reform labout markets, and privatise some more state-owned enterprises, but the major reforms had already happened.

Benny Lava – that’s quite possible too. There are always other things going on in the world economy. We can’t do clean experiments in macroeconomics. This is what makes me a skeptic whenever someone states, without any caveats, that cutting government spending will result in a worsening of the economy, as far as I know there just isn’t the data to support this as a sort of univeral law.

Bill – I can’t show that a reduction in aggregate demand, where we are currently at 70% plus capacity utilization and 10% unemployment, and we are at a 1% interest rate, will turn us around. As far as I know, no one in macroeconomics has solved the aggregation problem. All I will observe is that I don’t know of anyone who can show that an increase in government spending, when we are currently at 70% plus capacity utilisiation and 10% unemployment will turn us around either. They can present models in which this happens, but those models miss out a lot. Do they miss out important matters that would change the story around? Possibly. My skepticism is about the claim that cutting government spending always leads to a worsening GDP outlook.

Brian J – in NZ Ruth Richardson cut benefit payments, as in lowering the weekly rate paid for unemployment, introduced user pays for rich people for a number of health services (these were eventually rolled back after she was no longer MoF). I don’t know if this counts as short-term or long-term spending reforms in the way you are thinking about them.

Steko June 10, 2010 at 4:53 pm

Greg:
“Steko, you lie like a rug. I said neither thing:

“The facts appear to refute your ideas that (1) Australia never experienced depression and (2) cutting spending was the key to recovery.””

Your words are there for everyone to read. You’re going to split hairs on “depression” vs “great depression” and claim I’m lying like a rug? Lawl.

“Constrast the US and Australia in 1938 — what makes the American depression “Great” it’s relative length and continued size. You don’t call the massive US depression of 1920 a “Great” depression because things got progressively better. They did in Australia as well. They didn’t in the US.”

They call it the Great Depression in all English speaking countries not just the US. The Great Depression is “great” because it was large in both depth and it’s reach around the world. That it was deeper in some countries then others would seem to be both obvious and unavoidable.

To attribute all differences in depth between the US and Australia to this one act is laughable.

To gloss over the commonly made argument that deficit hawks in 1937 caused the backslide and blame it on the New Deal or Keynesian ideas is either ignorant or disingenuous.

Jim Rose June 10, 2010 at 6:11 pm

Steko,

Thanks for your reply.

My remarks were more focused on the accuracy of your source. The great depression in Australia is under-studied, and statistics are poor. Errors and disagreements are common.

You also said that “1932-1939: A slow recovery.†

The Australian economy has returned to its long-term average unemployment rate by 1937. From 29% unemployment to 7.5% unemployment in 5 years!

The Australian economy performed far better that did the USA. Australia followed classical policy prescriptions. The USA tried fiscal stimulus and the suppression of competition under Hoover and Roosevelt.

mulp June 10, 2010 at 11:58 pm

aaron wrote: Taxes will eventually need to be raised a little (and made more progressive now), but spending needs to be constrained. Increasing spending on healthcare will only drive up prices. Prices are already high, so obviously price signals are not adequate to increase supply. What we need to do is invest now in increased suppply in the future. That means creating incentives for doctors to teach and train new doctors. And, creating streamlined specialization and certification for certain procedures and treatments to take some of the more mundane workload off of doctors. And grants and loan forgiveness for completing programs.

Here he demonstrates the common misunderstanding if the “laws of supply and demand.” His argument is by really increasing the supply of gold by more investment in mining gold at a marginal cost of $500 an ounce and at full production a capital cost of $300, then the price of gold can be driven below $300 an ounce.

The price of health care isn’t as high as it is because the supply is too low or the demand too high, but because the costs are too high – we are assured by doctors, drug makers, and insurers that profits are too low and if they go lower, they will leave the business. That means costs are forcing the prices to be as high as they are.

And if we look at the more government controlled systems of Germany, Israel, Japan, France, Canada, the prices are lower because the costs are lower.

US investment in many sectors from health care to energy to finance has been insufficient or misdirected so we have costs that are too high and constrain the economy and the ability to compete internationally.

Al Brown, in similar vein has the same inverted supply-demand understanding: “If we want to do something about unemployment, do away with the minimum wage and simultaneously cut taxes on low wage workers in such a way that roughly compensates.”

Besides the failure to explain the unemployment of college grads, unless you somehow think all college grads need to have their wages cut below the minimum wage, the statement argues the reason employers aren’t hiring more people is because the employers can’t off $2 an hour, or 50 cents an hour. Hey, you have a MBA, I’ll pay you a nickle an hour.

If the price of collard greens were reduced to a penny a pound, would you eat ten pounds a day? Lowering prices will not create demand for which no demand exists. The problem with supply-demand curves is only part of the curve is shown, and that is the generally straight section for equilibrium without the U-shaped supply curve and the constrained demand curve.

Jim Rose June 11, 2010 at 6:41 am

Steko,

Another problem with your Wikipedia source on the great depression in Australia is its references to New Zealand.

It said that “New Zealand where Michael Savage’s pioneering welfare state rapidly reduced hardship†

The factual problem is Savage’s labour government was elected in November 1935 after the end of the great depression in New Zealand.

Leading NZ economic historian Brian Easton at the Asia-Pacific Economics and Business History Conference, 17-19 February 2010 lists the NZ Great Depression from 1929 to 1935!

Matthew Wright in the September 2009 RBNZ bulletin refers to a sharp recovery 1934-36 after a National Expenditure Commission took a razor to government spending with many wage cuts. Wright estimated that the great depression in NZ lasted 18 months, followed by a fast recovery!

I might add that with the election of free spending labour government, there was a downturn in 1937 and an exchange rate crisis in 1938.

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