The intellectual bankruptcy of the austerians

It is both amusing and tragic to watch the advocates of fiscal austerity try and deal with the fact that the thin intellectual foundations for their approach have crumbled away, while at the same time the empirical evidence of their folly accumulates. I say thin not for dramatic effect: the economic textbooks tell us that this policy was foolish in the first place, so the austerians were always arguing something like ‘forget the accumulated wisdom of the past century, on the basis of two or three papers we know better’.[1]

So we have the latest annual report from the Bank of International Settlements, which is telling central banks to stop all this unconventional monetary policy stuff and get back to the serious business of eliminating... no sorry, ‘controlling’ inflation. Ryan Avent has an excellent commentary on the same report from last year, most of which could equally apply to this year's edition. Here I just look in detail at one of the report’s six chapters on fiscal consolidation. (As Mervyn King once said, central bankers’ obsession is fiscal policy rather than inflation.) In a section on the costs and benefits, after a first paragraph outlining the case against, we have this:

“There are reasons to be sceptical about all these arguments. First, even if the short-term adverse effects of fiscal policy on output (or fiscal multipliers) are somewhat greater than in the pre-crisis period, there is considerable uncertainty about their magnitude and no compelling evidence that they are large enough to render fiscal consolidation more difficult (or actually self-defeating).”

Just look at the language here: ‘sceptical’, ‘somewhat greater’, ‘considerable uncertainty’, ‘no compelling evidence’. You could write a paragraph like this about virtually any economic idea. Notice also the target and how it changes: it starts off in the wrong place, by implicitly assuming that if multipliers were smaller the policy would be costless, and then at the end the target is the much stronger position that fiscal consolidation is self-defeating.

It gets worse. In the next paragraph we have:

“Second, other factors almost surely contributed to unexpectedly weak growth. Especially in the euro area, investors’ worries about fiscal sustainability and liquidity drove up sovereign bond yields, putting a strain on bank and sovereign balance sheets and leading to more restrictive credit conditions.”

The first sentence is a non-sequitur. And then we get the euro periphery countries, but no mention of how this crisis was brought to an end not by fiscal consolidation but by the actions of the ECB. You would think the BIS would want to give credit to a successful central bank policy! Next paragraph:

“Third, larger multipliers do not necessarily undermine the case for an early or relatively fast adjustment. The argument for back-loading or slowing the pace of fiscal consolidation relies on the expectation that fiscal multipliers will decrease in the future or that economic growth will rebound significantly. However, if these expectations do not materialise, shifting the bulk of fiscal consolidation to the future would mean greater debt and higher debt servicing costs, making future adjustment even more costly and prolonged.”

Notice the language again: “do not necessarily”. The only way to make sense of this paragraph is that we are going to be stuck at the zero lower bound forever.

In the next paragraph we get that old chestnut, credibility:

“The case for back-loading fiscal adjustment also relies on the credibility of fiscal plans. Current governments will have to make commitments on behalf of future ones.”

This is just wrong, unless you are only thinking about the Eurozone periphery again. For ‘backloading’ fiscal consolidation to work, current governments do not have to commit to anything. You just need to believe that future governments, once the recovery is assured, will focus on stabilising and then reducing debt, rather than allowing debt to explode. As they invariably do. [2]

Don’t worry, its coming to an end:

“Finally, the impact of fiscal consolidation on growth extends beyond the short run. By restoring sound financial conditions, eliminating the risks associated with high debt and reducing the resources needed to service the debt, consolidation will lead to higher sustainable economic growth. As a result, its long-term benefits will more than offset its short-term costs.”

This is more like a recitation of an article of faith than an argument. It first says reducing government debt is good for long term growth. Let’s accept that: the main arguments against austerity have never involved suggesting that long term high government debt is good for you. It’s all about when is the best time to stabilise and reduce government debt. It is the final sentence that just does not follow. Because there are long run benefits to reducing government debt, it must be the case that the sooner we start the better? No. Exercise is good for you, but you don’t start when you are down with the flu.

This kind of thing is amusing sport for academics who are trying to put off getting down to serious work on a Monday morning. But of course it is tragic because the austerians, even though they have been soundly defeated on the battlefield of ideas and evidence, continue to call the shots on policy nearly everywhere. What to do about this tragedy? Just keep plugging away at the arguments I guess, although a bit of ridicule also helps convey the poverty of the austerian argument. But it is also up to others with more effective voices to point out that this emperor has no clothes. 

[1] There may also be an element of Keynes famous academic scribbler in this too. (“Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.”) There was a period - in the 1980s - when those economists studying at masters/PhD level might have been taught that the undergraduate textbooks were wrong, and that Keynesian economics was doomed. That proved to be a temporary aberration, Keynesian economics rejuvenated itself and in most departments it was restored to its rightful place at the centre of macroeconomic wisdom. But perhaps some of those now running policy did their PhDs during the 1980s, and never kept up with what happened subsequently.

[2] This is where obsession comes in. Occasionally a government fails to prevent debt exploding, and forces the monetary authority to monetise the debt, leading to hyperinflation. This is the central bankers’ nightmare. If you want to avoid this remote possibility at all costs, then you might be willing to sacrifice anything to do so, including the health of the real economy.