Duncan Weldon asks
whatever happened to deficit bias, and why
was austerity so popular when it seems to hurt two crucial groups of
electors. They are both excellent questions.
First, a quick recap of Duncan’s arguments. The standard view among
economists before the financial crisis was that economies were prone
to deficit bias: a tendency for government budget deficits and
debt (as a share of GDP) to slowly increase. [1] Although there are a
number of theories about why deficit bias occurs, several involve
voters being at best unconcerned about it, and at worst conniving in
it. Such theories are miles away from an electorate giving strong
support to a government campaigning on reducing the deficit.
Second, austerity keeps interest rates low. So not only does
austerity hit wages and profits, but it also hits those who rely on
interest income to supplement their pension, a group who in case you
need reminding have a high propensity to vote. Although asset values
have gone up as well, many in this group will be reluctant or unable
to turn this into income.
I try and answer both questions in this paper.
As with many things, I think the answer lies in the financial crisis.
Popular concern about government deficits will be much greater if
these deficits are at 'record levels', which they inevitably were
following the deepest global recession since WWII. A recession
initiated by a financial crisis is also likely to see consumers
reducing their own borrowing, and so (erroneous) analogies between
governments and households resonate. A recession initiated by a
financial crisis also makes the public receptive to the potential
power of these markets, and therefore to claims by those ‘close to
the markets’ that national disaster is just one more large deficit
away. Arguments from economists that rational markets would not be
concerned about government default when the central bank can create
money are met with a widespread belief that the recent crisis shows
markets are not necessarily rational. Markets become like a powerful
god who can only be appeased by the sacrifices prescribed by its
priests.
This is how, in the case of the UK, George Osborne was able to
redefine the goal of macroeconomic policy from the normal desire to
see higher living standards into the need to reduce the deficit. His
motives for doing so may have involved a
desire to reduce the size of the state, what I call deficit deceit, but uppermost in his mind was
that his strategy was popular. So popular, both among the electorate
and the media, that the Labour opposition eventually gave up on
arguing that there was an alternative.
A key corollary of all this is that the popular appeal of austerity
has a sell by date. Once people have stopped paying off their own
excess debt, market panic becomes a more distant memory, and the need
to control the government’s deficit seems less compelling. The
underlying factors that created deficit bias can resurface. Quite
when that sell by date will be depends on particular national
circumstances. In the UK the game was up when the country voted for
Brexit, but I suspect even without that austerity would not have won
the Conservatives two elections. So the popularity of austerity is
short term.
As to the political economy question, I think that be a genuine puzzle if austerity was a long term phenomenon. But as it is not we
need to bring in (hopefully) short term failures of knowledge and
information. I have not noticed campaigns to ‘save our savers’
also arguing for less austerity, and I suspect the reason is because
they just do not see the connection. Who makes that connection for
them? Here
is Chris Dillow complaining that the media just does not do this kind
of thing. Central banks should, but for their own reasons rarely do. People may not act in
their own self-interest if they do not know what is in their own
interest, and in the short term at least this knowledge may not be
made available to them.
[1] To preempt the
usual MMT comments, this bias relates to economies where monetary
policy takes care of output and inflation stabilisation.
