Monday, February 20, 2012

Austerity

One answer to critics of the Obama administration's economic policies can be expressed in a single word: Europe. As Paul Krugman's NYT column yesterday points out, most of the governments in Europe actually tried what the president's critics have been demanding. They cut government spending, tried to reduce deficits, and encouraged people to practice austerity. The results have been slow or negative growth, high unemployment, and high interest rates. Whereas in the United States, where at least at the federal level we increased government spending and cut taxes, we have seen a return to economic growth, reduced unemployment and low interest rates. Krugman has consistently suggested that if we had run even bigger deficits, and used that money to assist state governments in maintaining public sector employment, we could have done even better.

These are hard lessons to grasp. Common sense tells most people that if our income falls during tough times, we must cut back on spending. That might work for individual families, but when the government tries it, the result is only to prolong the economic downturn. That's because the government needs to make up for the reduction in consumer spending by maintaining and even increasing, public sector spending. I think another part of the reason we are afraid to increase spending during a recession is that we mis-define the problem. A lot of people think the problem began with, or continues to be the debt. And so they make the common sense assumption that you can't spend your way out of debt. You will only make the debt worse. But what if the main problem was not the debt? What if the problem was economic contraction? It turns out you can spend your way out of that because spending causes economic expansion. We can turn our attention to deficit reduction after we have restored the economy to growth.

People who question or criticize these assumptions behind the administration's economic policies of the last three years should have an obligation to point to a working model that proves that a policy of reduced government spending would have led to a better result. The counter-model turns out to be right in front of us. It is Europe, where misguided austerity policies seem to be leading that continent to a double dip recession. Meanwhile, in the U.S., the economic situation is improving every day. Our major economic concerns right now are that Europe's mishandling of its economic problems could affect our economy; and that the American opposition party's plans for reduced government spending could cause us the same kinds of problems they are experiencing in Europe. If we didn't have to worry so much about people with the wrong answers trying to undo the progress of the last several years, we would be able to enjoy and appreciate that progress a lot more.

2 comments:

  1. I like the idea of requiring the supporters of Austerity to point to a single successful example to support their position, though in Republican Land where "up" is "down", evidence of a contracting economy would be "proof" of an "expanding" economy.

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  2. I would have said Europe has been trying to spend their way out of this mess for years -- after spending their way into it. This is another one of those things the best economist in the world do not agree on. And even as we look back at history it is not clear which method is more or less successful as adjustment lags in some parts of the economy can induce compensating volatility in others. Both sides can make an argument that fits their model.

    We can argue about which way is better twenty years from now but here is how it is going down in Europe ===>

    Fromm WSJ exclusive interview: European Central Bank President Mario Draghi said:

    “.. there is no escape from tough austerity measures and that the Continent's traditional social contract is obsolete.“

    He said Europe's vaunted social model—which places a premium on job security and generous safety nets—is "already gone," citing high youth unemployment; in Spain, it tops 50%.

    “You know there was a time when (economist) Rudi Dornbusch used to say that Europeans are so rich they can afford to pay everybody for not working. “That’s gone” Draghi said. “There is no feasible tradeoff between economic overhauls and fiscal belt tightening."

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