Daniel Gros has a Vox piece attacking the Krugman/Layard manifesto. Like Stephanie Flanders here, there is part of me that is tired of going over this again and again, as the arguments on the other side do not get any better. But I know that this is a battle we have to win, if only so that others do not need to fight it a third time. And I did have one new thought.
Before that, let’s just go through the economics one more time. Macroeconomic theory is as clear as it can be that austerity in the current situation will reduce output and raise unemployment. That is the theory in undergraduate textbooks, or modern microfounded theory. The evidence is also about as clear as it ever is in macro.
On the other hand, the ‘evidence’ Daniel Gros uses is of the following kind. The US recovery has been similar to that in the Eurozone, and the US had more initial fiscal expansion, so therefore austerity is not that important. These are the kind of arguments we use to persuade our students that they should take a course in econometrics.
But here is my new thought. Why not apply the same arguments to monetary policy. Interest rates were reduced faster and by more in the US than in the Eurozone, but the recovery has been similar, so clearly monetary policy does not matter much either. In the UK the recovery has stalled even though interest rates are zero. In addition keeping interest rates very low can cause longer term problems, so start raising them now, if not yesterday! No one (almost) makes this argument, because it is so obviously silly. So why do good economists think they can make the same argument for fiscal policy?
The only defensible argument for austerity now is that we have reached some critical debt limit, but the low level of interest rates on UK and US debt (and everywhere else besides the Eurozone) kill that dead. Everyone is agreed that once recovery is complete, we do need to start reducing debt. Everyone also agrees that when the recovery is complete, interest rates need to rise. But almost no one is arguing for higher interest rates now. So why fiscal austerity now?