Sachs and the age of diminished expectations

I do not normally talk much about the US economy, because there are so many others writing articles and posts that can do so with more authority. But I am getting increasingly fed up with people telling me that US growth disproves the idea that austerity is bad for you at the Zero Lower Bound (ZLB). Jeffrey Sachs just joins a long list.

Of course the proper way to tackle this is as Paul Krugman does. As he says other stuff happens (like a large fall in the US savings ratio in 2013), so you need to go beyond a single country and look at lots of data. However this might leave the impression that somehow the US case is unusual and does not fit a Keynesian story. In this respect I did a simple exercise, the results of which are shown in the chart. It shows actual US GDP, and a hypothetical path based on 2% real growth in government consumption and investment from 2009. So instead of austerity, we maintained government spending at the elevated levels seen at the bottom of the recession. In addition I’ve assumed quite a large (and instantaneous) multiplier of two on that extra government spending.

US GDP, billions of chained 2009 US dollars.

Now if the US recovery proved that Keynesian analysis was wrong, we should get nonsense out of an exercise of this kind. If the recovery was just fine with austerity then replacing it with something like fiscal stimulus and assuming a large multiplier should give us ridiculous rates of growth. Yet as you can see, the no-austerity GDP path looks perfectly plausible. What we get is 3.4% growth in 2010 (compared to an actual of 2.5%), followed by three years of 3.7% growth (compared to 1.6%, 2.3% and 2.2%). In other words we get a reasonably rapid recovery from a deep recession. Obviously there are more sophisticated ways of doing this kind of counterfactual, but maybe something very simple can make the point. With recent US experience, there is no case against Keynesian analysis to answer. 

This suggests to me two things. First, lots of people are desperate to show that critics of austerity at the ZLB are wrong, and are prepared to make nonsense arguments to that end. This may be particularly true if you very publicly proclaimed the need for austerity in 2010 (note the co-author: HT John McHale). Second, it is a sad day when anyone thinks that 2.3% growth is “brisk” when we are recovering from a deep recession and interest rates have remained at the ZLB. It is so very dangerous when these diminished expectations become internalised by the elite.