It appears that even Nancy Pelosi has embraced belt tightening. She states that the US “must enter an era of austerity” [my emphasis]. Since both Harry Reid and Barack Obama propose huge cuts in federal spending there is no reason to expect an outcome that puts people to work and restores the already draconian cuts to public services, including education.
Unfortunately, the arguments against austerity in recessionary times necessarily involve economic theory and a little bit of history, which are both alien territory for selfish Republicans and, to our collective regret, far too many Democrats who should know better. That said, we can understand how the austerity advocates have prevailed.
There is a simple notion that has gained far too much traction: a government should be run like a financially responsible household. Washington, D.C. should not spend more money than it takes in. Indeed, a responsible government would sock money aside for rainy days; in other words, build and maintain a budget surplus.
I’m all in favor of this proposition, especially the surplus part—if we were living under more normal conditions. But we’re not, and this is where matters leave the satchel of shibboleths and enter the more arcane territory of economic theory.
The departure is complicated by two challenges: (1) denial that we’re mired in abnormal circumstances; and (2) a refusal to admit that the problems we face demand extraordinary, deliberate actions rather than merely sitting back to await the magic of the market.
Economic thinking amongst academics can be generally divided into two broad camps: Keynesians and, well, non-Keynesians. The latter take their cues from University of Chicago professors, notably Robert Lucas, Jr., who is alleged to have uttered something to the effect that mentioning the name of Keynes invited derision among serious economists.
There is still much debate on what Keynes meant in his writings. However, his book General Theory reveals his essential thinking on macroeconomics. His Chapter 12 on long-run expectations provides a workable précis of recessions and how to recover from them.
Basically, during periods of low aggregate demand (i.e., not enough people buying enough things), both the producer and the consumer are locked in a stalemate, with neither willing or able to extricate. The producer (or investor) declines to hire people because he has no need to crank out more widgets, since people aren’t buying. Consumers, on the other hand, have experienced either stagnant or deflated wages, and with almost 15 million people out of work, lack the means to purchase goods and services. Keynes believed that both actors during recessionary times suffer from significant “uncertainty,” or lack of confidence. In response they retreat, retrench, or otherwise stop spending. Who can break the logjam? Keynes said only the federal government—by stimulating the economy (fiscal measures).
Here is where we encounter severe obstacles. The Republican Party as a whole refuses to increase taxes, even on the wealthiest, so as to increase government revenues and thereby reduce the deficit. Indeed, the Republicans want to lower taxes even more. (And recall that US tax rates are the lowest amongst the OECD countries.) Their plan is to slash government spending, which is precisely the opposite of Keynes’s prescription. Moreover, this new austerity won’t work, as even the Economist magazine pointed out.
A second obstacle: Republicans and non-Keynesians believe that government stimulus leads to higher inflation. Well, if anything, the economy suffers from too little inflation. Let’s look at the numbers from the Bureau of Labor Statistics:
The fainter gray line represents “core” inflation, all items less volatile food and energy prices. The darker line shows all items. It should be clear that the $700 billion+ stimulus package did not usher in a period of high inflation.
Nor should there have been any suspicion that it would. The collapse of the housing bubble wiped out about $8 trillion in asset value. Also, between 2008 and 2009, the Gross Domestic Product actually fell—by $1.6 trillion.
Yet, the stimulus package, itself a result of compromise with the selfish Republicans, was less than half the amount needed—and most of that was in the form of more tax cuts. When push came to shove Obama sided with the pragmatists in his advisory ranks, ignoring the recommendations of Christine Romer et al. who pushed for a real stimulus (fewer tax cuts) of at least $1.5 trillion, enough to close the gap in GDP.
Krugman, who has written a forward to a new edition of Keynes’s magnum opus, offered these words in March:
Why not slash deficits immediately? Because tax increases and cuts in government spending would depress economies further, worsening unemployment. And cutting spending in a deeply depressed economy is largely self-defeating even in purely fiscal terms: any savings achieved at the front end are partly offset by lower revenue, as the economy shrinks.
There. Austerity only exacerbates the problems. Mr. Reid? Ms. Pelosi? Are you paying attention?