Monday, July 7, 2014 provided another example of Paul Krugman explaining why austerity was an insane response to the Great Recession and the New York Times authoring another of its endless articles that assumes that austerity is essential to a eurozone recovery. I have no problem with the NYT reporters providing their rationale for why they concluded that Krugman was wrong and that austerity is the proper response to a recession. My problems are with the NYT reporters ignoring Krugman's views -- views shared by the great bulk of economists -- and with their failure to question whether austerity is the proper response to a recession.
Recessions occur when demand becomes seriously inadequate and industries fire workers and decrease production and investment. Austerity further reduces already inadequate demand by reducing public sector demand. Austerity is akin to bleeding the patient (the economy) to make him well. It would, therefore, be exceptionally strange if austerity were to be the optimal response to the Great Recession. We have a great deal of real world experience in dealing with recessions that confirms that austerity is self-destructive in such circumstances.
The U.S. Under the Automatic Stabilizers and Stimulus Program
Even the EU recognizes this fact by providing for (minor) fiscal stimulus (deficits are supposedly capped at 3% of GDP) when confronting a recession. There is no fixed definition of "austerity" or "stimulus." The U.S. initially responded to the Great Recession through its "automatic stabilizers" which automatically produce a significant budget deficit. Consider that sentence for a moment. There has been an overwhelming consensus among economists for over a half-century that "deficits" of this nature are "stabilizing" -- they reduce the length and severity of recessions. The U.S. then added to the automatic stabilizers by adopting a "stimulus" program. Due to politics (including divisions among Democrats due to the "Blue Dog's" opposition) the stimulus program was far too small (it provided only a fraction of the lost private sector demand) and had design defects (far too much of it was in the form of tax reductions for the wealthy -- the category that produces the weakest bang for the buck in stimulus terms). Despite these weaknesses it produced a far stronger recovery than the eurozone.
The U.S. Moves Toward Austerity
Unfortunately, Treasury Secretary Geithner, who has no economic expertise, increasingly became President Obama's dominant economic advisor. Geithner was a vitriolic foe of stimulus. As I have explained in prior columns, Obama became convinced that a budgetary "Grand Bargain" with the Republicans would be his legacy policy. That Grand Bargain embraced austerity. Obama and the Republicans have failed to reach the Grand Bargain, but their piecemeal bargains have pushed the U.S. steadily toward austerity, greatly slowing our recovery from the Great Recession. The U.S. fiscal deficit is now so small that the U.S. would comply with the EU's austerity regime. That means our deficit is far too small.
The Eurozone Recovers through the Automatic Stabilizers Until Germany Demands Austerity
The eurozone's initial response was also through its automatic stabilizers, which helped bring it out of recession. The EU's automatic stabilizers are weaker than those in the U.S. but still substantial. At that juncture, however, Germany and its allies demanded the imposition of austerity and the rejection of fiscal stimulus. This threw the eurozone back into recession and Spain, Greece, and Italy (with roughly one-third of the eurozone's total population) into Great Depression levels of unemployment. It became normal throughout the EU's periphery for university graduates to emigrate. Germany also demanded that the nations of the periphery slash their wages and make it far easier to fire workers. Inequality is surging in nations that were once far more egalitarian. Germany's political and economic hegemony over the EU is now blatant.
The Faux Morality of Government Budgetary Surpluses
A sovereign nation with a sovereign currency (such as the U.S.) is not "just like a household." We know households best so we have been conditioned throughout our lives to think of a budget deficit as unquestionably bad and a budget surplus as unambiguously good. We moralize these two states of accounting -- a surplus is virtuous and a deficit indicates a moral failure. Interestingly, we have very different rules in the corporate sphere, where one of the best ways to be fired as CFO would be to pay off all corporate debt. But sovereign states are neither households nor corporations and their "deficit" is simply another sector's "surplus." That does not mean deficits are irrelevant -- context is critical. It does mean that during a recession the effort to run a governmental budget surplus will, unless the Nation is a very strong net exporter, reduce growth and slow the recovery or even -- as it did in the eurozone (and in the case of Spain, Greece, and Italy) -- throw the economy back into a gratuitous second recession (or Great Depression).
The EU is about to Double Down on Austerity
Almost all eurozone governmental budgets are in deficit. That is as it should be, but size and context matter, and the eurozone deficits are far too small to spur rapid growth. Eurozone nations are still the beneficiaries of very modest stimulus via the automatic stabilizers. Germany, however, demanded that the infliction of much more severe austerity in the future. Given its domination of the EU, whatever Germany demands becomes EU rules. Over the next few years those rules will require the eurozone nations suffering from Great Depression levels of unemployment, the entire periphery, and core nations with weak growth to run increasingly large budgetary surpluses. That is a prescription for gratuitously forcing nations back into third recessions or depressions -- and for long-term stagnation. Even the leading troika apologist for austerity, Olli Rehn, stated that under the troika's policies it would take Spain a decade to emerge from the "crisis" phase. 2024 is 16 years after the acute phase of the original crisis. Rehn gave no estimate of how long it would take Spain to fully recover under the troika's policies -- and his estimate (implicitly) assumed there would be no further downturns for at least a decade. He also implicitly assumes an unbroken continuum of German austerity policies dominating the EU. I have written several columns explaining why austerity will cause extreme political changes in the EU. The NYT article I am about to discuss in more detail makes clear that Rehn's implicit assumptions are unlikely to prove correct.
The NYT's Inability to Write Coherently about the EU Crises
Roughly one-third of the eurozone's population is living in nations with Great Depression levels of unemployment because Germany demanded the infliction of austerity in response to the Great Recession. This is significantly crazed. It tells us that German hegemony over the EU is a disaster that is sowing the seeds of a future political crisis. It also tells us how bad economics and economists are. Any doctor that bled a patient (yes, I know there are a few specialized treatments that use leeches) to make them well would lose his or her license. But economists who engage in similar malpractice and bring misery to scores of millions of people have a very different fate in Europe (and Chicago). They are promoted and made finance ministers, the head of the ECB, and even the Prime Minister of Italy.
But perhaps the NYT believes that Krugman and most economists are wrong and austerity is the best response to the Great Recession. That could explain why they repeat endlessly and without any critical thought Prime Minister Angela Merkel's mantra: "there is no alternative" (TINA) to austerity. The latest exemplar of this is their July 6, 2014 story: "France Puts Euro Zone Recovery at Risk, Economists Warn."