Austerity, Solution or Problem?

(click here for this Austerity discussion transcript)

Here are quotes from four articles by Paul Krugman. He's criticizing the obsession of European and USian leaders with austerity, and his solution appears to be growth stimulus. What I would like to do is expand what we learned in the Apple Economics talk. What I would like to figure out is, how do Paul Krugman's suggestions work in our Apple Economy? Is he taking into account the basic problem of the virtual economy in his solution? What might be the differences between "expansionary policy" "inflation" and "growth"? This isn't going to be an easy discussion, but it might be very rewarding.

Death of a Fairy Tale
For the past two years most policy makers in Europe and many politicians and pundits in America have been in thrall to a destructive economic doctrine. According to this doctrine, governments should respond to a severely depressed economy not the way the textbooks say they should — by spending more to offset falling private demand — but with fiscal austerity, slashing spending in an effort to balance their budgets.
Critics warned from the beginning that austerity in the face of depression would only make that depression worse. But the “austerians” insisted that the reverse would happen. Why? Confidence! “Confidence-inspiring policies will foster and not hamper economic recovery.”

Easy Useless Economics
A few days ago, I read an authoritative-sounding paper in The American Economic Review, one of the leading journals in the field, arguing at length that the nation’s high unemployment rate had deep structural roots and wasn’t amenable to any quick solution. The author’s diagnosis was that the U.S. economy just wasn’t flexible enough to cope with rapid technological change. The paper was especially critical of programs like unemployment insurance, which it argued actually hurt workers because they reduced the incentive to adjust.

O.K., there’s something I didn’t tell you: The paper in question was published in June 1939. Just a few months later, World War II broke out, and the United States began a large military buildup, finally providing fiscal stimulus on a scale commensurate with the depth of the slump. And, in the two years after that article about the impossibility of rapid job creation was published, U.S. nonfarm employment rose 20 percent — the equivalent of creating 26 million jobs today.

Those Revolting Europeans
There seems to be little if any gain in return for the pain. Ireland has been a good soldier in this crisis, imposing ever-harsher austerity in an attempt to win back the favor of the bond markets. According to the prevailing orthodoxy [of austerity], this should work. In fact, the will to believe is so strong that members of Europe’s policy elite keep proclaiming that Irish austerity has indeed worked, that the Irish economy has begun to recover.
But it hasn’t. And although you’d never know it from much of the press coverage, Irish borrowing costs remain much higher than those of Spain or Italy, let alone Germany. So what are the alternatives?

One answer — an answer that makes more sense than almost anyone in Europe is willing to admit — would be to break up the euro, Europe’s common currency. Europe wouldn’t be in this fix if Greece still had its drachma, Spain its peseta, Ireland its punt, and so on, because Greece and Spain would have what they now lack: a quick way to restore cost-competitiveness and boost exports, namely devaluation.

As a counterpoint to Ireland’s sad story, consider the case of Iceland, which was ground zero for the financial crisis but was able to respond by devaluing its currency, the krona (and also had the courage to let its banks fail and default on their debts). Sure enough, Iceland is experiencing the recovery Ireland was supposed to have, but hasn’t.

Talk to German opinion leaders about the euro crisis, and they like to point out that their own economy was in the doldrums in the early years of the last decade but managed to recover. What they don’t like to acknowledge is that this recovery was driven by the emergence of a huge German trade surplus vis-à-vis other European countries — in particular, vis-à-vis the nations now in crisis — which were booming, and experiencing above-normal inflation, thanks to low interest rates. Europe’s crisis countries might be able to emulate Germany’s success if they faced a comparably favorable environment — that is, if this time it was the rest of Europe, especially Germany, that was experiencing a bit of an inflationary boom.

So Germany’s experience isn’t, as the Germans imagine, an argument for unilateral austerity in Southern Europe; it’s an argument for much more expansionary policies elsewhere, and in particular for the European Central Bank to drop its obsession with inflation and focus on growth.


Europe’s Economic Suicide
Consider the state of affairs in Spain, which is now the epicenter of the crisis. Never mind talk of recession; Spain is in full-on depression, with the overall unemployment rate at 23.6 percent, comparable to America at the depths of the Great Depression, and the youth unemployment rate over 50 percent. This can’t go on — and the realization that it can’t go on is what is sending Spanish borrowing costs ever higher.

Spain wasn’t fiscally profligate — on the eve of the crisis it had low debt and a budget surplus. Unfortunately, it also had an enormous housing bubble, a bubble made possible in large part by huge loans from German banks to their Spanish counterparts. When the bubble burst, the Spanish economy was left high and dry; Spain’s fiscal problems are a consequence of its depression, not its cause.
Nonetheless, the prescription coming from Berlin and Frankfurt is, you guessed it, even more fiscal austerity.

This is, not to mince words, just insane.

Europe has had several years of experience with harsh austerity programs, and the results are exactly what students of history told you would happen: such programs push depressed economies even deeper into depression. And because investors look at the state of a nation’s economy when assessing its ability to repay debt, austerity programs haven’t even worked as a way to reduce borrowing costs.

What is the alternative? Well, in the 1930s — an era that modern Europe is starting to replicate in ever more faithful detail — the essential condition for recovery was exit from the gold standard. The equivalent move now would be exit from the euro, and restoration of national currencies.

The Continent needs more expansionary monetary policies, in the form of a willingness — an announced willingness — on the part of the European Central Bank to accept somewhat higher inflation; it needs more expansionary fiscal policies, in the form of budgets in Germany that offset austerity in Spain and other troubled nations, rather than reinforcing it. Even with such policies, the peripheral nations would face years of hard times. But at least there would be some hope of recovery.

1 comment:

  1. Excellent article! Looking forward to the talk today.

    ReplyDelete