Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 18 December 2015

Exploring one set of reasons why austerity happened

In a new paper (here or here) based on my talk at the IMK anniversary in Berlin, I discuss the intermediaries between academic economists and politicians. Very few politicians have much knowledge of economics themselves, and so rely on intermediaries to transmit that knowledge. One important intermediary, particularly if you are not in government, is the media, and another is what Paul Krugman called policy entrepreneurs. In government you have the civil service. In the case of fiscal policy, central banks are a potential intermediary.

In the paper I look at how needless austerity could represent a failure in that transmission mechanism. I do not think for one moment that they are as important a reason as political opportunism by those on the right that want a smaller state. But I still think they are important, particularly in helping to explain why so many on the left feel unable to counter the populist line that the government must ‘tighten its belt’ even in the midst of the deepest recession since the war.

It is also important in explaining how opportunist politicians can get away with it. Just imagine if central banks had used their models to quantify the impact of austerity, and had made that analysis public. Imagine also if there had been some authoritative way of conveying the wisdom of the majority of academic economists, like the National Academy of Sciences in the US or the Royal Society in the UK. In the UK and US I think that might have made a difference.        


  1. When Osborne laid out his stall to the City at the Mais lecture shortly before the 2010 election he relied heavily on the recent work of Reinhart & Rogoff to motivate his austerity platform. They performed the functions of policy entrepreneurs while also being respected academic economists (and rather shockingly they don't seem to have entirely lost the latter status).

  2. I think the problems are this:

    1) Economics is not a science in the sense that physics or biology are. Importantly, economics in the academic sense is much more of a science than many of its critics will admit. However, this prejudice has a lot of traction such that economists do not have the credibility to the wider public that is needed.
    2) The mainstream media doesn't know the difference(or doesn't care) between an academic economist who researches and publishes (in the peer-review sense) and a 'city economist' who's narrow purview is to pursue what is good for the financial sector.
    3) The mainstream media doesn't know (or doesn't care) very much about what they report. It is quite clear that most economic correspondents are not well informed on their subject. (For reference, there's an interesting spot on the Now Show (R4) with Robert Preston where he shows his contempt for economists.
    4) To some extent, economics is at risk of personal bias in a political sense. Because economic theories and models inevitably have policy implications some will be favoured by some parts of the political spectrum and others by others. This bias exists in any discipline but economics appears to have more of a weakness. For example, the IMF is notorious moneterist and has done a lot of damage in many countries that it was mandated to provide aid to. This is despite the excellent research work done within the IMF. However it demonstrates the problem that all to often, arguments are from authority rather than from the evidence.
    5. In an political economy like ours their will always be tensions between various interests. The long-term trends to 'corporatism' and an economy that favours rent-seeking are worrying. However they go mostly unnoticed as so much of the media is owned and influenced by large corporation and rent-seekers.

    Just my thoughts... ;-)


  3. In the U.S. after the financial crisis was "over," and the Republicans took the House, the conversation turned to deficit reduction and austerity. I think a lot of it was couched in anti-Obama terms and even Obama himself talked of the need of deficit reduction.

    But whenever Bernanke had press conferences or sessions with Congress, he would describe how fiscal austerity was hurting the economy. But politicians and the media would ignore his message. The media would report it without comment. Perhaps he could have made himself heard somehow by speaking more emphatically or working journalists who reported better. It didn't seem like he cared if the message got out.

  4. I wonder whether there is a mismatch between what academic macro-economists view as the correct aim of economic policy and what central bankers view as the correct aim. Academic macro-economists perhaps want to ensure maximal output. By contrast central bankers want to eliminate any risk that "their" currency loses out to competing currencies. You talk about the post-2010 period as being a waste since we have missed out on economic out-put. But perhaps from a certain perspective the post-2010 period has been a triumph. Lately, the developed world currencies have trounced the emerging market economies. Up until 2010, the developed world was having to share an ever greater proportion of global output with the growing emerging economies. Since 2010, that phenomenon has been knocked on the head. Perhaps job done for austerity? It seems evil to me but perhaps that is what was wanted?

  5. My usual refrain: "austerity" has not happened in many countries.

    Consider the USA and the UK: stock markets are doing well, property markets are doing well; especially compared to the alternative. For a lot of people there has been a huge boost of prosperity, not austerity: in particular most people above median income (and even more so above *average* income) have done pretty well, as they tend to be asset owners, and benefit from expanding credit and leverage. People below median income have to deal with lower wages and higher rents, but "politically" they don't matter, and without effective trade unions they don't matter in the market either, especially with enormous incoming flows of competitors with lower income countries eager to win the race to the bottom.

    So while there has been no "austerity" in many countries, rather there has been a big redistribution from voters long labour to voters long assets, thanks to "privatized keynesianism" (as well named by C Crouch).

    Even Greece did not have "austerity": they had a monstrous government and trade deficit at the *top* of the cycle, as they followed a (wilful and fraud-based) policy of pro-cyclical capital inflows, and up until 2014 the greek government simply reduced the pro-cyclicality of their policy, Stopping spending the proceeds of asset sales when the assets run out is surely not "austerity".

    Overall most countries like the USA and the UK have run an anti-austerity policy (even if weak in overall effect outside asset markets), where strongly expansionary credit policy has been countering somewhat contractionary fiscal policy, and they have done so very, very deliberately, and this has been very popular with voters above median wages, who think that overall they are long asset beta and want it turned into alpha.

    I really can't imagine that politicians suffer from being unable to understand the «intermediaries», be they the central bank or the media, as per my usual G Osborne and D Cameron quotes:

    ««A credible fiscal plan allows you to have a looser monetary policy than would otherwise be the case. My approach is to be fiscally conservative but monetarily active.»
    «It is hard to overstate the fundamental importance of low interest rates for an economy as indebted as ours… …and the unthinkable damage that a sharp rise in interest rates would do. When you’ve got a mountain of private sector debt, built up during the boom… …low interest rates mean indebted businesses and families don’t have to spend every spare pound just paying their interest bills. In this way, low interest rates mean more money to spare to invest for the future. A sharp rise in interest rates – as has happened in other countries which lost the world’s confidence – would put all this at risk… …with more businesses going bust and more families losing their homes.»

    At least in the UK politicians know very well what they are doing, and they made those statements rather publicly and winningly, so voters can be assumed to know, at least in intuition, what they are voting for.

    The reason why the left is not countering this policy of (mild) anti-austerity made of strong credit expansion and mild fiscal contraction is exquisitely political: voters above median income are very much in favour of a policy that overall redistributed from below median incomes to above median incomes (and in the case of the UK from the North to the South), and people with below median incomes tend not to vote or to vote in seats that don't matter to returning a parliamentary majority.

  6. Also, given that I think that in most countries, in particular those you name, overall policy has not been of "austerity", but (mildly) anti-austerity, your arguments don't make sense to me unless you are trying to argue for one or more of these policy changes (or some obvious variant):

    #1 Policy should have have roughly the same mildly expansionary stance it has now, but with a mix of mild credit contraction and strong fiscal expansion, rather than viceversa.

    #2 Policy should be overall strongly expansionary by having far more credit expansion than it has now (which is what I think P Krugman, B DeLong, and most other right-wing New Keynesians advocate) while leaving fiscal policy mildly contractionary, and the inflation target should accordingly be raised.

    #3 Policy should be overall strongly expansionary by switching from mild fiscal contraction to mild fiscal expansion (or in the case of Greece to enormous fiscal expansion like in 2001-2011, funded by no-strings-attached fiscal transfers of $50 billion a year), while leaving credit policy strongly expansionary, and the inflation target should accordingly be raised.

    My guess is that you continue to use "austerity" to mean just "fiscal contraction", and you don't seem to care either way that credit policy is strongly expansionary, as you don't mention that much or the combined effect of fiscal and credit policy, so probably you are arguing for #3. But then sometimes you seem to argue for even more expansionary credit policy, so you may be arguing for #2, or even for both #2 and #3.

    PS as currently practised in most "financialised" economies, strongly expansionary credit policy is largely fiscal policy too, because the expanded volume of credit is never meant to be repaid *net*, but to be rolled over "indefinitely" (or parked in the capacious balance sheets of the central banks or in their off-balance sheet vehicles), or to be soft-defaulted "eventually".

    PS a fascinating discussion could be had as to why the current overall mildly expansionary anti-austerity policies in the USA and the UK are having an even milder expansionary effect on the real economy, while the financial side is booming.

  7. If the Euro was an open question, why was that? Was it because Brown had a good feel for the economics? To counter balance the enthusiasm of Blair he gave the debate oxygen and academic credibility? Without that Blair might have led us to disaster? The reverse is the case with austerity. The financial sector economists, who see the UK as an organisation rather than an economy, were given voice. Surely the responsibilty to ensure that impartial and complete advice is given rests with the senior officials?

  8. "It is also important in explaining how opportunist politicians can get away with it. Just imagine if central banks had used their models to quantify the impact of austerity, and had made that analysis public. Imagine also if there had been some authoritative way of conveying the wisdom of the majority of academic economists, like the National Academy of Sciences in the US or the Royal Society in the UK. In the UK and US I think that might have made a difference."

    You and Corbyn need to change the debate into real terms IMV. What is Osbourne planning to do with all the nurses he sacked?

    The word "debt" is completely loaded and when someone hears it they change to "moral cognitive mode". Their brains shut down and they go on a frenzy like a headless chicken.

    Have you quietly explained that the deficit is simply the saving rate of the non-government sector, and that it comes out about the same pretty much regardless of the level of taxation for any given level of aggregate demand.

    Spend £100 more and you'll get about £90 back as taxes and about £10 increase in net savings (saving or paying back bank loans.) Regular as clockwork.

    I really don't know what we have to do to explain to people that government controls the *distribution* of taxation, but doesn't really control the %age of spend collected back.

  9. In the US some of us expect the POTUS to use the bully pulpit occasionally for such purposes, but are frequently disappointed.

    1. Obama used the bully pulpit to tell Americans that government needed to tighten its belt, just like families were doing. If you read some of these contemporaries histories, I think you'll conclude that Obama, like FDR, Truman, et al, never has been comfortable with deficits, especially because the US owes so much to foreigners.

  10. Prof. Wren-Lewis-- I only know about the politics of austerity in the United States, but I know a lot about that, having been a politics and economics junkie almost all of my 70 years. It's almost impossible to convey to an economist how totally ignorant the public is about macroeconomics, and the same is true of politicians and pundits, even those who are good liberals on most issues. They do not understand the difference between potential GDP and actual GDP and how the latter is cause by the level of demand (as opposed to poorly educated workers or excessive government regulation). Most importantly, they are totally wedded to the naïve notion that a sovereign government is just like a family or business. Sure, debt for college or to expand your business is ok, but more and more debt just to meet your annual expenses seems obviously bad to non-economists, even educated liberals like Barack Obama. Virtually everyone in America, from Obama on down, assumes that our national debt and deficits are out of control, and that we literally can't afford to repeat something like the 2009 stimulus, even those who might concede it did a little good.

    If you haven't read it, I suggest Noam Scheiber's "The Escape Artists" for a blow-by-blow description of the White House politics of dealing with the recession. Even if the Dems hadn't lost big in 2010, Obama would never have pursued any more stimulus, and would probably have moved to cut the deficit steadily on his own. It wasn't because the Fed experts weren't vigorous enough with pro-expansionary advice. It's because ordinary people, and the politicians who need their support, just cannot accept the idea that larger deficits might be a good thing when we have a $18 trillion national debt. This is especially the case now that so much of our debt is held by foreigners. People just can't understand how this could not be a major burden on our children in the future.

    All this is why I have come to really favor monetary financing of deficits. Yes, "printing money" is politically toxic too, but it is much easier to explain why it doesn't mean instant hyperinflation, so I see this as ultimately more politically palatable. I wish we could get the most prominent economists like Krugman, Stiglitz, and Summers to start introducing the idea to the public. But the reason is not economics, it's politics.

    Thanks for all your efforts.

    1. Nick, I haven't paid attention to economics all my life, but I've been paying fairly close attention the last twenty years and trying to read some economic history when I can. In regard to Obama as an "educated liberal," I think his "education" was at the hands of laissez faire Chicago school economists strongly influenced by the Austrians. In other words, liquidationists. I think Larry Summers chose to go along with his prejudices rather than try to show him where he was wrong. Remember that at his dinner for right-wing columnists in January 2009 he stated openly that he believed "reform" of "entitlements" was necessary. He explained that he meant Social Security and Medicare had to be reduced or the country would suffer financial collapse. In 2010 he announced a freeze on federal government hiring, and, in fact, in his administration the number of federal employees has risen less than any time since the Eisenhower administration. I really fear what might happen under a President Trump, and am scared to death of a President Cruz.

    2. I don't disagree about Obama's ignorance about economics. But I think he has confessed to never haven taken it, rather than takes the Chicago version.

  11. I am not an economist so while I want to contribute a couple of observations that seem pertinent, I don't want to bother everyone with my interpretation. I have been a bureaucrat and a loan officer. My observations are: 1, generally bosses do not (cannot?) admit the error of their "programs." 2. While this was still held as an "operative principal" I remember one time as a loan officer when the boss realized he had erred (and so corrected himself). In a economic downturn in the 1970's the company suddenly decided to restrict lending by two means (one probably would have been sufficient). In six months loan account had fallen almost disastrously. The result; suddenly all the vice presidents began visiting each office and told all 1800 loan office managers that we had misunderstood. We should not have overreacted so, moreover, we needed to understand, the company was a lending company and we needed to start making loans again. It was we who were responsible, not the boss.

  12. Austerity and the utter scientific ignorance of economists
    Comment on ‘Exploring one set of reasons why austerity happened’

    “In order to tell the politicians and practitioners something about causes and best means, the economist needs the true theory or else he has not much more to offer than educated common sense or his personal opinion.” (Stigum, 1991, p. 30)

    Economists lack the true theory and because of this they have nothing to offer but some political opinion. The market economy does not work as standard economics says. This holds — with damaging consequences — in particular for the labor market.

    The core of labor market theory goes as follows “We economists have all learned, and many of us teach, that the remedy for excess supply in any market is a reduction in price. If this is prevented by combinations in restraint of trade or by government regulations, then those impediments to competition should be removed. Applied to economy-wide unemployment, this doctrine places the blame on trade unions and governments, not on any failure of competitive markets.” (Tobin, 1997, p. 11)

    Until this day, the representative economist has not realized that the OVERALL systemic interdependence establishes a POSITIVE feedback loop between ‘the’ product and ‘the’ labor market, that is, wage rate down - employment down - wage rate down - and so on. Vice versa with an increasing average wage rate. The market system is NOT an equilibrium system. All equilibrium models are a priori false.

    The most elementary version of the correct employment equation reads

    From this structural equation follows inter alia

    (i) An increase of the expenditure ratio rhoE leads to higher employment.

    (ii) Increasing investment expenditures I exert a positive influence on employment, a slowdown of growth does the opposite.

    (iii) An increase of the factor cost ratio rhoF=W/PR leads to higher employment. This implies that a higher average wage rate W leads to HIGHER employment. This is, of course, contrary to conventional economic wisdom. It is, though, easy to prove that conventional wisdom is a mere fallacy of composition (2015).

    The complete employment equation is a bit longer and contains in addition profit distribution, public deficit spending, and the trade balance with the rest of the world.

    (i) and (ii) translate into Keynesian anti-austerity policy, which has its own drawbacks. Let us focus here alone on the factor cost ratio rhoF as defined in (iii). This variable embodies the price mechanism which, however, does not work as the representative economist hallucinates. As a matter of fact, overall employment increases if the average wage rate W increases relative to average price P and productivity R.

    The correct employment theory states that the average wage rate must rise on a global scale in order to prevent unemployment and deflation. For the relationship between real wage, productivity, profit and real shares see (2015, Sec. 10)

    With the provably false standard employment theory economists bear the intellectual responsibility for the social devastation of unemployment. The political discussion about austerity is somewhat beside the point. It is the market mechanism which is defective at the core and economists have not realized this in more than 200 years.

    The only remaining talking point between politicians and economists is to bring an action for damages.

    Egmont Kakarot-Handtke

    Kakarot-Handtke, E. (2015). Major Defects of the Market Economy. SSRN Working Paper Series, 2624350: 1–40. URL
    Stigum, B. P. (1991). Toward a Formal Science of Economics: The Axiomatic
    Method in Economics and Econometrics. Cambridge, MA: MIT Press.
    Tobin, J. (1997). An Overview of the General Theory. In G. C. Harcourt, and P. A. Riach (Eds.), The ’Second Edition’ of The General Theory, volume 2, pages 3–27. Oxon: Routledge.


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