People Are Finally Figuring Out: Austerity is Stupid

[logic_man]

Quote from Ed Breen:

Piezoe, you wrote: "one fact remains overwhelmingly supported by actual economic data and that is that increased spending is a far more effective means of stimulating the economy in times of recession than are tax cuts." That is simply wrong. You say it, but you offer nothing to show it, not even a reference to any study.

The accepted academic expert on the subjec is Christina Romer and she has written the seminal paper on the subject which we have discussed in this thread and where you can find a link to the paper.

I don't agree with Christina Romer on most things and I have criticised her paper but she is the one who put the data together in a paper and her paper is the standard on the issue. I have to tell you that she says you are wrong. Her studied conclusion is that there is more benifit from tax reductions...though she really can't prove a 'multiplier' from either strategy.

I remember reading an article where Romer had come quite close to repudiating her own findings. Ah, the wonders of politics when it comes to intellectual integrity.

The primary reason tax cuts actually help economies come out of recessions, from what I've read, is timing. Tax cuts don't require jumping through all sorts of hoops to get the money "out the door", or, in this case, stop the money from coming in Congress' door. Couple that timing factor with the fact that local knowledge of which consumer and business demands are most urgent, i.e. when I get that tax cut, I know exactly what I want to spend it on or what I want to invest in, whereas Congress needs to, as I mentioned, jump through a bunch of hoops in coordinating with the various governmental bureaucracies that exist, and of course tax cuts will have a more immediate effect.

People who think government spending is a better fix for an ailing economy must have never gone through a government appropriations process. In fact, anyone who is a proponent of government spending is probably below the median in overall "worldliness" and prefers to dwell in the world of theory over practice. Well, the real world isn't Schoolhouse Rock where bills become laws become real-world projects in a New York minute. Just ask Mr. "I guess shovel-ready doesn't really mean 'shovel-ready'", i.e. Obama himself.

 

[toc]

Is not stimulus a type of spending? If I am not wrong, all the 3 stimulus introduced have resulted in profits to the government. Profit on stimulus is not the main question, having economy growing is.

I do not believe in spending to jump start the ailing economy. It is like giving half dozen Red Bulls to a man with flu. He will be active for a little while but eventually will be down with more sickness and being over caffeinated will have problems sleeping. Restful sleep is a very strong cure.

Spending cuts should balance the budgets and result in no more borrowing.

Tax cuts should be balanced off by the spending cuts but result in more disposable income to the general population. Best is, this tax cuts in today's economic environment is immediately thrown back into economy in forms of bill payments, securing immediate needs etc. and thus account for growth. This growth in turn increases the business revenues and thus profits and these businesses are then able to invest into new production and assets. Hope this makes sense.

 

[Ghost of Cutten]

Quote from Ed Breen:


As I suggested in my comment there is no econometric study that can show that spending creates a sustainable money multiplier in the economy. If you just use common sense you would know that you cannot create wealth simply by spending money on consumption; you have to torture yourself with academic nonsense to think that you could.

But Keynesian policy generally does not recommend spending money on consumption, it recommends spending money on investment i.e. build infrastructure projects, more schools and hospitals etc.

 

[Ghost of Cutten]

Also, austerity is not a policy choice, it is a consequence. Austerity is 'chosen' the moment that unsustainable investments are made en masse at irrational bubble prices, or when the government decides to ramp up borrowings during a mature economic boom. After a gigantic asset bubble bursts and causes a nasty recession, or the government runs out of borrowing capacity, the GDP is going to shrink regardless of government policy. The government's choice is merely whether it shrinks via default, bank runs, devaluation and inflation, or via 'austerity' i.e. making sure that the debt burden does not become so high that the markets start fearing default and dramatically jack up the cost of government spending.

Consider the cost of German government spending when bunds yield 1.5%, versus the cost of Greek or Spanish government spending. Each hospital or school Greece wants to build is going to cost it a fortune in interest payments, whereas for Germany it is almost free to borrow the money.

It is definitely better to have to restrain spending (i.e. austerity) than to experience the chaos of a financial system meltdown (e.g. Argentina 2001) or hyperinflation spiral. The secondary effects and costs of systemic collapse are enormous. So, this puts a limit on Keynesian spending, even if one agrees that cyclical deficit spending makes sense (which is not a foregone conclusion).

Also, due to political realities, the real world outcome of Keynesian policies is clearly ongoing structural deficits during good times and bad. Until a better political decision-making system is designed, Keynes will just be used as an annual fig-leaf for pork-barrel spending. Not only does this retard growth during periods of economic expansion, it also reduces the government's fiscal firepower during actual recessions.

 

[Ghost of Cutten]

Quote from toc:

Is not stimulus a type of spending? If I am not wrong, all the 3 stimulus introduced have resulted in profits to the government. Profit on stimulus is not the main question, having economy growing is.

I do not believe in spending to jump start the ailing economy. It is like giving half dozen Red Bulls to a man with flu. He will be active for a little while but eventually will be down with more sickness and being over caffeinated will have problems sleeping. Restful sleep is a very strong cure.

Not really - an economy is not quite comparable to a man with flu, so the analogy doesn't hold.

One argument for temporary deficit spending during a recession is that risk aversion becomes irrationally high, and this both increases the return on capital demanded by the private sector to make investments, and reduces the cost of capital of government spending. When Treasuries yield under 2% and the equity risk premium is 5%+ (and unlisted businesses will have to offer even higher returns to attract capital), government spending provides a relatively more attractive return on capital than during normal times (where the ERP is often more like 2-3%). One should also consider the lasting costs of long-term unemployment - eroded job skills, loss of motivation, knock-on effects on crime, domestic violence, harmful addictions, family disruption etc.

Given that some spending is necessary anyway - one must periodically upgrade schools, hospitals, roads etc, and build more as the population and the economy grow over the long-run - then surely it makes sense to spend on such upgrades when spare labour capacity is high and cheap, funding costs are very low, and alternative uses of capital risky and uncertain. Rather than when the labour market is tight, funding costs high, and alternative avenues for investment are plentiful and relatively safe.

The fact that it may boost animal spirits, if they are excessively depressed, is a final factor in favour. Basically, the benefits of government spending are biggest in recessions, and the costs of them are cheapest during such periods. If done properly, the payback will come once the economy is expanding again and society can more easily afford the spending cuts or tax rises needed to bring the debt level back to normal levels. One may even find that a good proportion of the spending paid for itself - after all, only some government spending is wasteful, not all of it. Highways, schools, police stations, hospitals, courts, and military assets still exist and serve their function after being spent on.

If we look at the real world evidence, it seems that structural deficit spending over many years does not work. Prime example being Japan 1990s-2000s. However, temporary deficit spending seems to work quite well e.g. the initial Roosevelt administration. If a political system arose that limited deficit spending to actual recessions and their immediate aftermath, and then went to mandatory balanced budgets once GDP turned positive for a certain length of time, then we could get more data points and evidence as to the effectiveness of this policy.

 

[Ed Breen]

Logic Man, of course she repudiated her own findings. She wrote the seminal paper at Berkely that concluded that tax cuts were more effective as stimulus than government spending but then she was tapped by Obama to head his counsel of economic advisors where all of the other players wanted to spend money as stimuls and not reduce taxes. She actually rationalised proposing that the first Obama stimulus plan spend 1.2T and it was only Larry Summers that talked her down on political reasoning to get behind the modified plan and spend only 800B. She showed she was political and principled as an academic.

Notice that in your discussion of tax cuts v. spending you buy into the demand side model that assumes the purpose of either tact is to promote consumption. Even in recommending a tax cut strategy you would do it in a Keynesian stimulus paradigm to promote consumption. Recovery and growth occurs only with increased investment. Increase in consumption depends on production.

 

[toc]

While Clinton left a balanced budget in 2000 (although lot of it to do with capital gains tax revenues from the internet boom), George Bush came in and introduced Tax Cuts for the rich. This was not offset by spending cuts but instead by spending increases of two wars, one of which was uncalled for. Rest is history.

Do the real rich really reinvest the tax savings immediately into the economy or tax savings for middle and poor classes results in higher consumption in a much faster momentum. I bet the economic growth is higher in the second case. Rich also have the habbit of investing overseas to get higher returns from places like emerging markets etc.

It is about time there is a Third party in the US something on the lines of 'conservative democrats' with non partisan agendas.

Also, US needs to curb on illegal immigration as the majority of their earnings are sent overseas and these earnings are resulting from NO tax payment to the US government. Curbing illegals might also reduce the unemployment levels in the tax paying population and thus result in higher consumption and less government spending on unemployment and welfare support.

Such measures fall well into 'austerity' part of the economic map.

 

[Ed Breen]

Ghost of Cutten, you are right that Keynes makes clear in his Generl Theory that he recommends government investment and not consumption or indescriminate spending. Keynes did not consider the deficits that government carries today, he did consider that sovereign solvency would be an issue. He also was nieve to think that government could actually invest in assets without cronnyism; that government actually could invest effectively. Somehow, those who cliam Keynes as thier brain trust, have so distorted his theory so much that they can casually profess that all governemnt spending is the same (Obama has made that claim) and that government is a competent investment arbitor. Keynes talked about government investment supplementing a deficit of private investment; he did not advocate unrestrained government spending on consumption or favored groups.

 

[Ghost of Cutten]

The real question here is not 'whether' governments should 'pursue' austerity or not (their hands are mostly tied), but how to make any slump as short as possible, how to achieve recovery as soon as possible, and how to maximise the long-term growth rate subject to the economic and political constraints that apply.

What you want is for markets to adjust as rapidly as possible to the reduced economic activity, and reallocate resources swiftly in the most productive manner. This means get the market clearing price reached as soon as possible, avoid barriers to markets clearing (especially the labour market), encourage swift debt writedowns and liquidation of genuinely bad/unsustainable enterprises.

Every market has a clearing price. In the real world, non-efficient markets take time to clear. In recessions the problematic market is the labour market - one with quite high transactions costs and illiquidity. So, the first step of the government should be to maximise the ability of the labour market to clear, and reduce the costs of doing so.

Policies that would achieve this would include a temporary reduction or suspension of minimum wage legislation, easing the cost of relocation, rolling back red tape and giving tax breaks to the recruitment of new labour and commencement of new investment projects, and so on.

Another common problem in recessions is the stickiness of wages and other prices (e.g. commercial rents, debts). Governments need to accept that maintaining public sector wages during recessions when private wages have fallen significantly is unsustainable. It would be best to put in some kind of structural public sector pay formula that links it to GDP, so public employees know in advance that their pay will be frozen, or if necessary cut somewhat, during recessions - in the heat of the moment, politicians just won't risk the backlash from being seen to be individually responsible for cutting pay. Special legislation to encourage realistic and swift write-down and reduction of sustainable debts and long-term rental agreements would also be useful.

New capital formation comes from new business formation, expansion of existing business - this is directed by entrepreneurs and business managers at corporations. So, we should encourage entrepreneurial activity and business investment - this is what will create new jobs and growth. Government spending that actually boosts growth e.g. needed infrastructure upgrades, increased resources in law and order, will also help.

 

[toc]

Wish there was a huge and well defined separation between economics and politics. Sadly, these two a interwined very strong when they should be separated by far.


That is why, I am hopeful that Romney is elected and plays non selfish agenda. He is rich already and has strong business turnaround experience, so decisions made should be more economy focused, hopefully.

Obama did fine politically but did not impress with the economy, the real need of the hour.

ps: I do not like Republicans but need of the hour is selfless turnaround specialist.