Have we seen self-defeating austerity in the United States?

Everyone has been talking about the revised CBO deficit forecast, which suggests the short-term U.S. fiscal picture is more favorable than had been realized.  It can be said that in the short- to medium-term, the deficit is no longer an issue (in my view that was the case anyway, but that is a different story.)

But I am puzzled as to how the whole story is supposed to fit together, at least from an Old Keynesian perspective.

For instance, we have been told that the United States has been engaged in a good deal of fiscal austerity in the last few years.

We also were told that fiscal self-austerity was quite possibly self-defeating (or here, pdf) or at the very least fairly close to self-defeating.  That is, it would make budget balance harder rather than easier.

The amount of attention, and the fervor of the rhetoric, also suggest that this was seen as a major issue, not one minor to moderate factor with seven other significant confounding factors operating on top of it.  Admittedly this latter point is more of a subjective impression, but I believe many people have shared it.

OK, now here goes the potential story.  We did fiscal austerity, it was self-defeating, that was a major factor, and we ended up in…a better budget situation than we had been expecting?

It is fine to say “our budget situation could have been better yet,” but then the fiscal austerity story then seems to collapse into one factor among many confounding factors.  Which is fine by me, but it is not the story we seem to have been receiving.

I am myself comfortable arguing something like “when underlying fundamentals are sound, and/or there is monetary accommodation, an economy can withstand fiscal consolidation just fine.”  That is simply a more specific variant of the above.

Another “way out” is to question whether “austerity” is always to easy to measure, given the associated modalities and baselines involved in its current definitions, and given the multiple dimensions of fiscal policy, and so perhaps the degree of austerity has not been nearly as high as we were told.  I can buy that too, but still it would be news to the Old Keynesian accounts we have been reading.

So what’s up?


An excellent post, if I may say so, Prof. Cowen. This is EXACTLY why I like reading MR. I mean, I am, more or less, in the camp that said 'deficits are self-defeating'. Now, I was not quite in the 'they're a major factor' camp.

Why? Because you nailed it: There were plenty of co-founding factors. Sumner and Nunes is quite correct to say that the greater Fed interventionism may well be behind the better results of the USA now than the USA in the 30s when the same amount of fiscal retranchement led to a collapse back then.

I would also add that the CBO numbers in the medium term do change thanks to the curbing of heath care costs. Another co-founding factor.

I would still use Europe as a rebuttal, though. When fiscal 'consolidation' is done without expansionary monetary policy to try and stymie the bleeding, you get bad outcomes, including D-t-GDP ratios going bad...

The problem with fiscal consolidation is that it's being done in the fact of still high unemployment. Without the decline in fed & state spending, there would be 1 - 1.5 % less unemployment. That's 1-2 million people without jobs. It's about the human costs, not long term budget issues...

Okay, let's look at the Krugman article you link to:

"There’s a quite good case to be made that austerity in the face of a depressed economy is, literally, a false economy — that it actually makes long-run budget problems worse."

He says "long run". Why are you arguing that a short term improvement in the deficit contradicts that claim? Of course you can improve the short-term budget deficit by raising taxes and cutting spending - but you then have to deal with high unemployment now and potentially longer time to return to trend growth from the sheer waste of human capital.

"But this long run is a misleading guide to assessing our infinitely malleable models. In the long run we are all correct."

Because lamenting long run budget problems is antithetical to Keynesian policy.

No, it really isn't. It is antithetical to the strawman of Keynesianism presented by conservatives. It is perhaps only antithetical to MMT, a view which Krugman (and many forms of Keynesians) expressly do not hold.

Of course it is. Keynes himself acknowledged that Keynesianism tends to create recession in the long run, but that short run considerations were of greater importance, all things considered. One certainly doesn't have to straw-man Keynesianism to acknowledge its actual trade-offs. What is surprising is the extent to which many modern-day Keynesians assert that no such trade-offs exist.

But they do exist, and I am not someone who believes that the long-run always trumps the short-run. I think it's worth it to actually assess the considerations in light of the circumstances. It's dishonest, on the other hand, to make an argument in favor short-run policies while attempting to peg its long-run consequences on the opposition. I understand why it would be politically beneficial to make such an argument, but neither am I someone who believes that political expedience is of higher value than the truth.

Where does Keynes say that counter cyclical fiscal policy leads to recession in the long run?

And which modern Keynesians suggest there are no trade offs when implementing a counter cyclical fiscal policy?

Um, no, that has nothing to do with what Lord Keynes said. Please go to either Delong or Krugman from the last week or two and read any of the like 15 different articles both of them posted entirely and soundly defeating your claims re Keynes.

There are no "trade offs" with a properly done keynesian policy in that it is markedly superior to any other approach to macroeconomics that has yet to be discovered and is the only one that has any marked-to-reality validity.

Mike hess: Please see GregH's comments above for denial of trade-offs. I'm not going to go digging up chapter/verse citations for what I assumed was common knowledge. I've been out of school for a while now and don't quite remember everything perfectly. Maybe I am nuts and there is no such thing as trade-offs and Keynes never thought there ever would be. Doesn't sound totally reasonable to me, but I'm no PhD....

You should read the primary texts instead of relying on secondary sources. Keynes has become so politicized that reading ABOUT his work can be deeply misleading.

It's hard to straw-man Keynesianism when the Keynesians are doing such a good job of it themselves.
UI benefits have a high multiplier and so on.

Do you have data that suggests they do not? On what data did they base those claims?

It seems just from a raw rationalistic analysis that UI should have an exceptionally high multiplier, putting funds directly in the hands of those most likely to use those funds to consume.

"“There’s a quite good case to be made that austerity in the face of a depressed economy is, literally, a false economy — that it actually makes long-run budget problems worse.”

Krugman seems selective in his use of "long-run". I thought we were all supposed to be dead.

Automatic stabilizers and monetary stimulus overcame fiscal policy austerity.

To be fair, I am also endlessly amazed about the American consumer ability to keep on going...

I'd like to see a breakdown of American consumption per broad income tranches, with some split between 'discretionary' and 'necessities/non-discretionary'.

What I am wondering is if, for a large chunk of American consumers, a big component of their spending is 'necessity-based' ; that would mean that, as long as they got a paycheck, they won't/can't save/reduce their spending.

i.e. consumption, for a large chunk of people, would be VERY sticky... Don't know if anyone thought seriously about that...

Well I guess it depends what you think is non-discretionary spending. The poor in the U.S. tend to have the same or more goodies than the middle class in Europe, but I think a lot of people consider e.g. cable TV to be non-discretionary.

but I think a lot of people consider e.g. cable TV to be non-discretionary.

Most people certainly consider cell phones and internet access as non-discretionary at this point. Cable TV, on the other hand, can be largely replaced with internet access.

Richard: Absolutely right, I was about to make the same post, but I see you did it for me. The answer to the OP is most prominently the Federal Reserve's heroic action on monetary policy propping up the economy in the face of austerity. Effectively the two are cancelling each other out. That said, I expect the CBO's predictions to be rather rosey going forward considering that inflation is barely at 1% which suggests our growth will continue to not only be anemic but perhaps more so than it thus far has been. Only if the fed responds to the fact that inflation is almost a full percentage below target with even greater actions will this likely not to be the case, in my estimation.

"Federal Reserve’s heroic action on monetary policy propping up the economy in the face of austerity."

Really? So monetary policy can stimulate, after all? We are not in a ZLB/liquidity trap situation where fiscal policy is extremely potent exactly because monetary policy can't do anything? That must be news to the Keynesian/Krugman camp!

Oy. Who wants to tell him?

You wonder at times why people don't read the work of the people they criticize.

I predict a seamless transition from "things are so bad we need to spend more!" to "things are so good we can afford to spend more!"

From voters, sure. From Keynesians? Until Krugman actually makes that point, that's slander, imho. Keynes was very clear on the necessity to save in good times.

BUT, one note of caution, this CBO report and signs of economic revival are all wonderful news BUT you still have high unemployment and dreadful workforce participation. Champagne popping IS a bit premature...

"Slander" is a bit melodramatic, don't you think?

Yes. That was for rhetorical effect. Though this is an assumption on my part, having been on political forums before with conservative Americans, I am somewhat tired of the Keynesians = Democrats = Big Spenders, when the reality (for whatever reasons) of the past 2 decades has diverged significantly from this dogma.

When this is pointed out, conservatives then usually say that 'Democrats only saved coz Rep Congress stopped them' (somewhat true) and 'We don't approve of Rep. spending either' - usually very false inasmuch as I haven't seen a conservative against the Iraq War back in 2003, against the Bush Tax cuts or for their repeal and they are usually quite opposed to any reform of the health care system on top.

The simple solution is to not spend much time engaging with heavy partisans. ;)

Part of an explanation of that is that Congress controls spending and taxing, not the President. It would be correct to view who has control of Congress as the driver of spending. Keynesians = Democrats = Big Spenders works out better in this light. Newt Gingrich was the last one to generate a surplus after all.

As for health care reform, opposing the ACA would be consistent with being a small sender, not big.

Again, I can reply to myself but not TMC. I understand blogs aren't forums but this is a frustrating set-up...

@TMC: Called and answered, your Honour.

There is some truth in the Rep Congress limit Dem Presidents. But this is done for partisan reasons, not ideological ones. The proof being that Rep Congress doesn't have a problem with an exploding deficit when the Prez is Rep.

As to ACA, my point was about the health care sector cost control. I don't actually like the little I understand of ACA. It seems to me to increase Demand for health care without addressing the gazillions Supply issues and medieval guild-like barriers health care suppliers create to extract ever larger rents.

But, again, the Rep opposition to ACA is purely partisan. It was, after all, a Rep designed plan... And, despite their 'repeal and replace' slogan, we've never seen the beginning of a 'replace' plan.

It's not clear to me that keynesians care what Keynes said of didn't say. I suspect the same can be said for a number of * that preceed *isms.

ding ding ding

already happening.

Depends on who wins the election in 2016.

This exercise is very unlikely to lead to any remotely uncontroversial conclusions. As Tyler says, measuring austerity is tough. I don't think most would say we have even had much of it. The the closest thing approaching austerity has been the sequester and some small tax increases this year. (States are another matter, and they have had very sizable reductions in spending.) The sequester hasn't hit that hard yet as those cutbacks are wisely being spread out, to the extent they can be. Remember all those people who have been arguing that even the UK hasn't really pursued fiscal austerity? Their cuts have been far more dramatic than ours. The other question is whether we really had fiscal stimulus. We could argue about that one, too.

It's been five years. Can we really say that anything in particular worked? Maybe monetary policy?

+1 on that too.

Though I think that the key for measuring fiscal austerity would indeed be with the states. They seem to have shouldered a lot of the 'consolidation'...

It's been a total muddle through on all fronts...

"Maybe monetary policy?"

Yes, exactly the one thing that shouldn't have worked at all, according to the keynesian models.

Probably the only intervention that wasn't completely stymied by political opposition. It didn't start strong, but monetary policy was the only tool used that wasn't totally half-assed.

So when interest rates hit zero and the Fed starts buying things we continue to call that "monetary policy". But if the government was doing the buying (for example a bank bailout) we would call it "fiscal policy". Whatever you want to call it this is not traditional monetary policy.

Re: "So, What's up?"

Ask Europe. Their unemployment has been increasing.

I guess that's Up.

So... confounding factors then?

What's Up now?

Yeah, what is confounding is that Europe is the austerity poster child, and now this site talks as if--even though we did not get full stimulus, and are doing our best to drag the economy down with recent austerity-- somehow we didn't have stimulus when Europe was too easily swallowing the austerity snake oil.

All is not lost, however. Look for the next round of stimulus--either Europe or the US--to be business tax cuts, or tax shifting, all in the name of stimulating the economy.

Who says you can't play a sucker twice.

What I find cofounding are the folks who bitch and moan about control groups in trials (ie Oregon Medicaid) then without hesitance, compare the US to other countries -- or groups of countries.

Ryan, Yeah, isn't the Eurpean austerity experience a bitch. I know, let's ignore it.

"Europe is the austerity poster child"

I do not believe that word means what you think that it means...at least, not when considering the nations that people generally think of when they think of Europe. Where are all of these mythical Euro countries that have actually instituted austerity? I can think of one in eastern Europe, where the austerity caused short-term pain and then incredible growth. Otherwise, not so much.

Well, last year I was to Spain, Portugal, Ireland, England, France and Belgium: based on observation, I think you might get into an argument about that in a bar. Might be fun to watch.

"I am myself comfortable arguing something like “when underlying fundamentals are sound, and/or there is monetary accommodation, an economy can withstand fiscal consolidation just fine.”"

You and Sumner are doing a wonderful job of nudging the bar on what constitutes a good/fine/or otherwise acceptable economy further and further down.


Monetary policy has kept the economy afloat, but sitting just above stall speed is not exactly the sign of a healthy/good/fine/whatever economy.

Why do people keep using the fraudulent government accounting numbers? The deficit is much wider than the figures most people source. The US government is hiding a good chunk of its expenses today by promising to pay them out sometime in the future. CFO's would get thrown in jail for such criminal activity and many companies with large deferred employee benefits went bankrupt back in the day when they were not required to account for the future promises they made.

Have government accounting standards changed recently? If not then as long as they are using the same bogus techniques as before then it should not matter much.

'The economy, stupid.'

Debt is a summary statistics of A LOT policy decisions and economic shocks, of course there's something for everyone to complain about, but I wish there was a little more introspection and little less finger pointing.

Let's ask ourselves the economic forecasting record of anyone in this cycle...pick any party lens or economic goggles and it's the same. The pro-stimulus crowd bears some blame for the current perplexing situation, stimulus is by definition temporary but they set far too short a window and didn't choose tools by efficacy. That worked in past recessions ... the economy always delivered a pop and the unwinding of fiscal support was brushed off. In defense of their current complaints, it is unusual in a recovery (almost five years!!) to have this much discretionary fiscal drag on growth.

Not to say I am pro-austerian either. Why not focus on the long-term unemployed? This is a massive waste of our very best resource and the long-term consequences of a hobbled labor market are massive. If austerians really care about our future economic health then this ought to be a priority.

Often the Great Depression is discussed in terms of policy failures and mistakes, but I wonder if it wasn't an economy failure. Standard channels got clogged, people got too beaten down to pop, and the usual virtuous circle broke down. This time is not as bad, but we seem to use a lot of the tools of a regular cycle (or close cousins) to calibrate our policy reactions to this cycle...to mixed effect.

Is this recession universal? Are all sectors facing under-employment? Or is there a constrained resource with incredible demand for labor?

If so, what is that constrained resource?

Hint: http://www.businessweek.com/news/2013-03-06/dearth-of-skilled-workers-imperils-100-billion-projects#p1

"...and about $120,000 a year after graduating from college..."

Another +1 on that bit especially: "This time is not as bad, but we seem to use a lot of the tools of a regular cycle (or close cousins) to calibrate our policy reactions to this cycle…to mixed effect".

I'll reference a blog-post I wrote (http://theredbanker.blogspot.com/2013/03/were-stuck-more-of-same-solution.html) about a Tim Taylor article (http://conversableeconomist.blogspot.com/2013/03/snowbank-macroeconomics.html).

Tim's point is that we tried fiscal stimulus and monetary stimulus pretty much as much as politically feasible. We can always argue, Krugman-like or Sumner-like, that we ought to have done more.

And maybe we should have. Actually, strike that. We certainly should have.

But our standard counter-cyclical tools do feel a bit dated. It was probably a good opportunity for some truly unusual solutions: Helicopter drops of money as per Yglesias' suggestion, if monetary stimulus is your thing, debt forgiveness and aggressive income redistribution if fiscal tools are more to your tastes...

Maybe it is that counter cyclical tools work for a while until they don't. If you start from the assumption that the strength of capitalism is failure, nothing else, and any benefits come as a result of the winnowing of bad ideas and practices, than any counter cyclical actions will tend to reinforce failure, bad practices and bad ideas. In time the accumulation of stupidity will cause a failure that cannot be remedied.

What was striking since the late 90's and since has been the stupidity of the marketplace, and how bad ideas have had enormous costs. Two bubbles, one following the other was unprecedented; some said that it couldn't have been a bubble in 2005 because we had just seen one. It was larger than that, I remember talking to folks in 2006-7 time where we saw retailers competing not on delivering selection and cost but how quickly they could spend $30 million putting up a store somewhere. The stupidity ran wide and deep, culminating in a failure in 2008 where policy, regulatory, financial and business acumen was proven to be idiocy.

Bad ideas are punished severely in a capitalistic system, but we saw the worse ideas were, the more widespread they were, the more costly they were, the less punishment because someone showed up to bail them out.

So we end up with an economy that didn't shed it's dead weight either in policy, government or businesses, rent seekers or any of the dead weight. So we end up with stagnant growth, unemployment and a general hopelessness.

Yeah, but if we just put another trillion on the credit card, it'll all come right.

the fiscal austerity story then seems to collapse into one factor among many confounding factors. Which is fine by me, but it is not the story we seem to have been receiving.

Why is it so hard to accept that austerity is only one among many factors? Which story has Tyler been listening to that says austerity (or the lack of it) is the only variable here?

How can Tyler so breezily connect one economic observable (say deficit) to another specific input (austerity) and draw any sort of causal relation?

Good and interesting post, although my issue with the Krugman/Delong/Summers math is that it merely compares a hysteresis assumption to a debt service cost assumption and ignores the more important issues. D/S focus on the case for stimulus and assume that:

1) The existing deficit never needs to be corrected, nor does the long-term upwards debt trend (this is perhaps further out now although I haven't read the new CBO document yet), which means that…
2) You get the benefits of stimulus without ever having to impose restraint - you just let the stimulus run off after one year but never reverse the additional debt because…
3) Debt can rise to infinity and you can always sell it at the exact same interest rate.

Krugman then takes the analysis to a new level of irrelevance by contemplating fiscal restraint but suggesting that its long-term benefits are limited to debt service reductions (D/S spelled out that they’re ignoring the direct effect of stimulus on the budget balance because they assume it runs off after a year, while Krugman doesn’t bother to clarify that he’s implicitly reversing the restraint and not giving any significance to its direct effect). He fully deserves the Laffer of the Left criticism that he fears.

If anyone’s interested, here’s my critique of the D/S paper:

I do not think that many people believe(d) that the inadequate fiscal stimulus and subsequent shift toward higher taxes/lower spending ever got to levels of self defeating. If the Fed does its job of keeping ngdp growing at constant rate, self defeating fiscal austerity might not be possible. [It might not be possible even in the Euro zone if ECB would do the same.] So the only narrative I think this news supports is the one that both "Keynesians" "Market Monetarists" and you accept, that deficits in the near term were not a good reason to move toward a less expansive fiscal policy and that measures like the sequester and the payroll tax increase were not properly justified by concerns with the long term trajectory of deficits.

Have you looked at the unemployment rate and employment / population ratio ?

The Krugman post linked to above quite clearly emphasizes the country's *long-term* fiscal position. I think it's entirely consistent with Krugman's writing to say that we've paid for the improvement in the short- and medium-term budgetary outlook with unnecessarily high unemployment and sub-optimal growth, both of which will be more damaging in the long-term than higher short-term deficits would have been. There's no great puzzle here.

I can't say I'm all that surprised. As the unemployment levels sank the need for stimulus eased as well. I wonder how much of these good numbers are the result of big profits from the Fed and Fannie? Seems like they bought low and are in a position to sell high.

Probably modern economy is too slow moving for Keynes to work like in the 1930.

1) Like TARP, the first stimulus was relatively successful of keeping the economy from falling too much and too fast. After the first couple years, the stimulus/TARP had limits and the private markets had started coming back.

2) A lot of the 'austerity' was the removal of troops from Iraq..

3) The economy had structural wage premiums issues not structural skill issues. (All job types took a whack.) The structural improvement is Chindia wages are growing so fast that there is no longer big outsourcing occurring and even some onshoring.

4) The energy boom is occurring and limits the impact of foreign oil prices. A Keynesian argues that the stimulus is needed so the private markets don't completely cut back too much.

5) A lot of sudden bounce back is housing comeback and the states no longer cutting back employees or spending. (No longer 50 State Hoovers) The job market in 2011 and 2012 was really held back from state employee cutback.

6) Health benefits were cut back instead of wages so consumers are either better shopping or avoiding certain medical expenditures. Also, short term drop in birth rates (nearly 10%) and drug price drops.

On a related note, how long has it been since we've heard a conservative or libertarian account tell us that there has been "no austerity," and that a debt reckoning is just around the corner? 2 weeks since a Martin Feldstein column? How bout a similar post here?

" tell us that there has been “no austerity,”

Who doesn't know this by now? The Sequester is about whether we increase the budget by a small or larger amount, not about a decrease.

Bernanke and the FOMC certainly think that at ZLB it would help to have some fiscal stimulus.

From the latest minutes:

"Information received since the Federal Open Market Committee met in March suggests that economic activity has been expanding at a moderate pace. Labor market conditions have shown some improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Inflation has been running somewhat below the Committee's longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable."


And, from February, Bernanke lecturing Congress on austerity.


What the hell? The deficit was cut through a tax hike, but this is not over, not for large swathes of the population. We still have major, long term growth and employment problems.

The answer is so simple that it makes me wonder what's up with you if you are actually confused. Yes, austerity is self defeating, but that doesn't mean that no recovery will ever happen, it just will happen slower than it needs to. You act as if any recovery is proof that current policy is working (or not hindering recovery) and that is obviously a ridiculous position to articulate.

Mild Austerity -> Deficit Reduction : "You said it wouldn't work, but it did! "

Mild Austerity -> Deficit Increase : "We told you it wasn't enough. Now see what a mess you got us in!"

Hardcore Austerity -> Deficit Reduction: "See, it works? We always knew that!"

Hardcore Austerity -> Deficit Increase: "It must have been some other confounding factor. Austerity gets a bad name for no reason. "

But obviously two can play:

Mild Stimulus -> Anemic Growth : “We told you it wasn’t enough. Now see what a mess you got us in!”

Mild Stimulus -> Strong Growth : “You said it wouldn’t work, but it did! “

Hardcore Stimulus -> Anemic Growth: “It must have been some other confounding factor. Stimulus gets a bad name for no reason. “

Hardcore Stimulus -> Strong Growth: “See, it works? We always knew that!”

So true. :)

Moral of the story: Don't jump to offhand, simplistic conclusions. Complex systems have complex behavior.

Thus the idiocy of point at either growth or the lack of growth and claiming austerity as correct or incorrect. The trick is comparing reality against an unobserved counterfactual. We all know this. Why is Tyler playing dumb?

I wonder, why don't the austerity or stimulus folks argue on the basis of track record, namely how much more accurately their own models predict growth/unemployment and deficits compared to those of their political opponents?

...mostly self defeating in the sense that we have been nibbling away at the edges of services provision, without finding better ways to account for them in wealth creation. What is now out of budget on the government sheet is not always well understood in the sense of private wealth capture or restructure. For instance, as Megan Mcardle pointed out last year when her mother came home from the hospital, family picks up where the healthcare system leaves off. While there is nothing wrong with family taking such responsibility, the point is that certain important aspects of healthcare are currently lost in the process and that also translates into aggregate economic loss. I like the better budget. I don't like that people haven't done a better job of translating ongoing need into ongoing productive economic activity.

meh. you lost me at "We did fiscal austerity"

We need a new word.

Does your profession SEEK to be misunderstood by the public?

Or do you simply prefer to keep it all within a self-referential jargon-laden ivory tower?

I know: viability. The US has taken steps toward viability. Heaven forefend!

I think we've taken a middle of the road approach on austerity. We initially provided a good deal of fiscal stimulus and increased the Federal budget. We have had a continuing resolution for many years, which essentially kept budget levels the same for most almost all appropriations. We have only recently cut the budget in a substantial or austere way. The austerity known as the sequester has likely barely been absorbed into the economy. Perhaps the effects will not be as large as economists have warned in the face of an otherwise growing economy, but its hard to say that the recent economic figures and this CBO forecast bolster the case of 'austerity to growth.' when fiscal cuts were so recently passed, and only now are spend plans actually being changed, acquisition packages cancelled, furloughs announced, etc.

Maybe the real story is that "austerity" in some sectors can be absorbed (defense spending) while austerity in other areas results in larger adverse effects.

Wu hit the head of the nail solidly.

Remember, by historic norms this has been a horrible recovery and we do not really have good explanations as to why.

Just maybe the major reason is austerity. If policy had been more aggressive would the recovery have been stronger?

I agree the recovery is horrible but I don't agree that we don't have an explanation. Strong recoveries are typically helped along by the credit expansion that occurs when those who haven't lost their jobs find themselves in a stronger financial position (due partly to falling inflation and interest rates). They're also usually fueled by a turn in the home building cycle. Neither of these ingredients worked this time because household finances, debt, home building and house prices had been so stretched in the boom that they all needed more time to recover. These factors have been discussed in research on the aftermath of financial crises (e.g. Reinhart and Rogoff) and the characteristics of balance sheet recessions (e.g. Richard Koo).

Reinhart and Rogoff? Are they out of the doghouse already?

Ha Ha. (but they didn't deserve the doghouse imo - they've done a lot of valuable work & the problems with the one paper were overstated).

I really get confused as to the economist definition of "austerity." It seems to me that austerity is merely not spending money you don't have. To take Krugman's definition, austerity is the failure to borrow today, spend today, and payback sometime tomorrow. The success of that is the spread on the borrowing costs versus the invested capital is it not?

Let's say without austerity we would have had 1 to 1.5M fewer people unemployed for the last 12 months. What would that have done to the deficit short and long term? No doubt 1.5M more people working would have meant a lot of tax dollars coming in as well as fewer dollars going out in various benefit programs. On the flip side, 'no austerity' means we would have either had more direct gov't spending (stimulus) and more tax cuts (for example, the extension or deepening of the Obama payroll tax cut rather than its expiration). Suppose all things together the deficit today would be exactly what it is now.

That would demonstrate self-defeating austerity. We could have had 1M more people working for the last year for the same deficit we have today. Over the long term what is the cost of 1M people not working for a year? It's not huge compared to our massive economy but the cost is very real and very serious.

This was an interesting post, and touched on few of the reactions I had after seeing the news. I think I'm in somewhat of a, well, pickle (http://ashokarao.com/2013/05/16/is-there-a-keynesian-pickle/).

Point is, I believed in self-defeating austerity. But my immediate reaction to the news that deficits are crashing was "damn, we needed to do more, what a shame". These two are internally inconsistent, because if I believed in the former, my measure of bad policy would be increasing deficits. Contrary to what I had. The linked post is a discussion thereof.

I'd add a few important caveats that, I think, ultimately vindicate DeLong/Summers:

1. To the extent austerity didn't *increase* deficits, it might not have decreased them either. This is a strong statement. It means that we've sustained unemployment and poor growth for no real purpose. And that's the spirit behind their work for Brookings, not that "austerity will send deficits through the roof."

2. Healthcare cost curve issues are supply-side, and hence a different conversation.

3. From my post "Ultimately, this is a question of meta-rationality. I'm not willing to update my beliefs about austerity, at least not with this news. We needed more, and we needed it for longer. But I do cede that my beliefs and reaction thereof were internally inconsistent. Further, the argument for self-financing may not be as strong as we once thought it might be. And even if it is, it seems very difficult to falsify."

I am unsurprised at the economic result. I figured we did "half a Krugman" in the stimulus phase, and something like "half a European austerity" after. Perhaps in both cases "halfs" were not optimal, but they were apparently, from the data, not that bad. I am surprised by the spin though. Are big gun economists really asking "if we did half an austerity why do we still have growth?" Self-answering.

Would a driver ask, if "I press my brakes with half firmness, why am I still moving?" Would they ask why they didn't go faster as a result?

When they had been told they'd wind up going backwards instead? Yes.

So Krugman continues to attack austerity based on the assumption that austerity cuts government spending. Maybe it is time for a reality check:


"A new study by Constantin Gurdgiev of Trinity College in Dublin compared government spending as a percentage of GDP in 2012 with the average level of pre-recession spending (2003–2007). Only three EU countries had actually seen a reduction: Germany, Malta, and Sweden. Not surprisingly, two of those three, Germany and Sweden, are among those countries that have best weathered the economic crisis. Those countries that have suffered most, Greece, Italy, Spain, and Portugal, have all seen spending increases."

There is a good chart here which shows 7 countries' response to the crisis. I think Cato is playing a bit with before/after when it should be viewed as three phases: before the crisis, immediate response to the crisis, and consolidation. The austerity comes (everywhere, including in the US) after immediate response, and in consolidation. Greece consolidated more than most.

In a contracting economy, the ratio of government expenditures to GDP rises even with austerity as long as the rate of economic contraction is greater than the rate of government contraction.

Krugman has made this point repeatedly. The more appropriate ratio is government expenditures to potential GDP. That Cato purposefully ignores this is unsurprising given the apparent joy they take in arguing with Keynesians made of straw.

how do you measure potential GDP? google is not giving a clear answer.

Well I for one deserve to earn far more than I do, so there's that.

"Krugman has made this point repeatedly."

So? If the economy shrinks while government expenditures stay the same or shrink not as much as the rest of the economy, then that still counts as "bigger government". Or let me make it easier for you:

Before the recession: 100 million total expenditures in the economy, 10 million paid by the government.

After the recession: 50 million total expenditures in the economy. 8 million paid by the government.

That Cato guys is correctly using government spending as a percentage of GDP to study the relative size of government. While Krugman wants us to measure austerity based on a non-existence "potential GDP" that supposedly shows how economy will "grow" if we follow his big plans. Who's living in Disneyland I wonder?

Perhaps a bit of people tending to get serious about austerity (actually taking steps) when the economy stops diving and starts to look like it might be getting better?

Basically - when it looks like the economy is in a freefall people are too worried about it to think about govn't deficits, when the economy starts to recover people start to get more worried about deficits and as it gets stronger deficits increasingly become unwanted. Austerity becomes a talking point when the economy has started to recover (or when debt gets unsustainable to the point of potentially not meeting the commitments) and therefore when it gets implemented the economy recovers, in part because it was already on the road to recovery.

Maybe... just an observation.

So the only thing we care about is the fiscal position better than we thought? I'm glad a tenured professor in a high income bracket thinks that all the suffering on the part of the masses these past 5 years means nothing.

And to think we added a mere $5 trillion in debt over that period, barely 30% of GDP. Heartless ogres of austerity!

I am surprised that so many people think that the deficit is no longer an issue because it has shrank from ridiculously large to just really large. There's STILL a deficit that gets stacked onto a large debt, we STILL have no easy way to pay it back, and there are STILL looming costs associated with the aging Boomers. How is this not a problem?

Wait, so we are slowly pulling out of the worst economic down cycle since the great depression and it turns out everything was fine? No, everything was not fine. That's the first point that needs to be made - the past 5 years represent a huge economic loss and if there were a different policy that could have done better, we should have pursued it.

I also am at a complete loss as to how this specific piece of data coming out contradicts a keynesian view of the economy. The economy is growing and that results in a falling budget deficit. You may be able to argue that Paul Krugman's specific claim regarding the impact of recent budget tightening in 2013 Q1 was wrong, but even within the Keynesian framework there's a judgement call about whether fiscal tightening will be enough to forestall a recovery. And it's not like we have tremendous growth here! We've experienced 400K/month job growth in previous recoveries and we are just now pulling above 200K/month growth. That's only great news given how bad the previous 5 years have been. PK may be 100% correct that without the sequester we'd see more growth currently and a lower 10 year budget deficit forecast. Given historical post-recession growth, this is hardly an outlandish claim.

There has been a bitter debate between the keynesians and the monetarists during this recession, but neither side has been nearly as vindicated as they each suppose. The recovery has been slow and we've gotten less of what both sides wanted, so how can we really say what was lacking? If we tried huge fiscal stimulus and got slow recovery with high inflation, that would be bad news for the keynesians. If we tried a Sumner like fed commitment to targetting the forecast level NGDP growth and failed to hit the forecast or just gotten lots of inflation, that would be bad for monetarists. But neither has been tested and failed.

It's only the austrians who look silly since Europe is running a combo tight fiscal and monetary policy and it's been disastrous.

How about James Surowiecki's New Yorker post of 4/15? It posits that the underground economy has grown significantly in the last five years, suggests that the deficit would be MUCH lower today with full tax compliance and quotes one economist who says the growth of consumer spending is consistent with unemployment at least one percentage rate lower than is currently quoted. The question isn't austerity. It is whether a country founded by people opposed to taxes is becoming, well, Grecian.

I'd still like to hear from Tyler why he chose to rebut two links specifically discussing the impact of austerity on *long term* budgeting by citing short term numbers.

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