The academic consensus on austerity solidifies, but policymakers go their own sweet way

With yet another study showing how damaging austerity can be, you would think that at some point some politicians would eventually get it. This tepid economic recovery has been a huge vindication of Keynesian economics, which also happens to be mainstream economics. The textbooks and state of the art macroeconomics said cutting public spending while interest rates were stuck at their lower bound was a very bad idea. And sure enough pretty well every ex post analysis of this period finds that it was. It is particularly ironic that at a time when countless articles have appeared about the ‘crisis in economics’, a massive experiment by policymakers has seen an important part of it vindicated.

There were three countries or areas that adopted austerity in spades: the US, the UK and the Eurozone. Are any of these likely to recognise the error of their austerity ways anytime soon? The conventional wisdom is that this will happen in the US, but this is to confuse actions and the reasoning behind them. Any fiscal expansion in the US would not be for Keynesian reasons. This is partly for the obvious reason that interest rates are rising, and the central bank has shown no clear sign that they would not meet any further expansion with additional increases. There remains a clear and rather urgent need for a large increase in public investment financed by borrowing, but that seems unlikely to happen. What we are sure to get is tax cuts, particularly for the rich, because that is nowadays the main goal of Republican economic policy. Among Republicans, Keynesian economics remains the work of the devil.

In the UK there is also a desperate need for public investment. In addition, the NHS is crying out for a substantial tax financed fiscal expansion, which would help get interest rates off their lower bound. But UK policy makers only have one thing on their minds at the moment. It is Brexit at any cost. We know that because they show no interest in any other options. Right now God could reveal to climbers on Ben Nevis that Brexit would cost the average UK household 20% of their income, and policy would not change. [0] While some in the government may be tempted by fiscal expansion as a way to hide those costs, the Treasury seems to be keeping an iron grip on the purse strings. Never has the UK government seemed so politically secure, and never has it been further from sensible economics.

Not all of the Eurozone’s problems are due to a failure to recognise Keynesian macro. As Martin Sandbu argues here, what has been done and continues to be done to Greece is the age old story of the creditor refusing to admit that they have made bad loans, and therefore squeezing the debtor for every last drop and not realising that doing so only makes things worse. But even here a failure to understand Keynesian economics contributes to this lack of understanding. A country that is allowed to recover from a demand led recession will be far more able to find resources to pay back debt.

However if you look very hard there are signs that things might be improving in the Eurozone. Fiscal austerity at the aggregate level seems to have come to an end. Some key actors, even in EC institutions and governments, are beginning to see how austerity policies may only encourage the rise of the populist right. But that is a long way from the key reform that is required, which is replacing the existing fiscal architecture with something more Keynesian that recognises the mistakes of the past.

If anything is going to happen at all, I doubt if it will be the abandonment of the stability pact and fiscal compact, desirable though that would be. What seems more likely is a gradual adaptation of the mess that all these rules already are. The adaptation does not even need to look like Keynesian policy. National fiscal and macroprudential policies need to focus on inflation differentials between the individual country and the Eurozone average. This focus could be embodied in a rule, which still allowed debt or the deficit to be guided by a target when inflation was at the zone average. This rule has to be symmetric in inflation differentials, prescribing fiscal expansion if a country’s inflation is lower than average.

Equally disappointing has been the complacency of independent central banks. We have had the most prolonged recovery from recession, with lasting damage to long run supply, but you might be forgiven for thinking that we were still in the Great Moderation. Central banks should be busy comparing the four main ways of avoiding another Zero Lower Bound episode: a higher inflation target, negative nominal rates, nominal GDP targets or helicopter money. They also have to stop being so discreet about fiscal policy. Keeping quiet itself makes another ZLB episode more dangerous.

Occasionally people ask why my blogs seem to be as much about politics as economics these days. I agree, there has been a change since 2015. Before that, I would have greeted a new paper on fiscal multipliers by comparing it to the existing literature, and examining its strengths and weaknesses. These days there just seems so little point. I do hope all this knowledge will one day see the light of day among policymakers, but right now I wonder if there is an equally good chance that policy makers will stop paying for knowledge they have no intention of using. [1] Sometimes writing about the finer details of estimated multipliers can seem like rearranging the deckchairs on the Titanic.

[0] Here are some man-made estimates

[1] U.S. U.K.