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Wednesday, April 27, 2011

Austerity Does Not Work: Contractionary Fiscal Policy is Contractionary

Austerity means less, not more:

UK, Not OK, by Paul Krugman: The bad GDP number for the UK isn’t a surprise — in fact, judging from market response, investors seem to have expected something even worse. Still, if you step back and look at what has been happening, it’s doubleplusungood: zero growth over the past 6 months, with every reason to be worried on the downside looking forward, as Cameron’s austerity bites deeper.

Jonathan Portes gets to the nub of it:

On fiscal policy, the message is that we should listen to economists, not credit rating agencies. Most mainstream economists argued that the impact of the government’s fiscal consolidation on confidence and consumer demand would be negative; so it has proved. …

In short, there is no confidence fairy... Portes hits, in particular, on a point I’ve tried to make a number of times, here and more recently here: right now, we’re living in a world in which basic economics points to conclusions utterly at odds with what Very Serious People are supposed to believe, in which radical outsiders base their views on standard economics while orthodox types turn to heterodox, highly dubious speculations.

Econ 101, buttressed if you like by fancier New Keynesian models, says that contractionary fiscal policy is, well, contractionary. Yet much of the world of movers and shakers bought into the exotic notion that expectational effects — the confidence fairy — would make contractionary policy expansionary. And they clung to this belief even as the supposed historical evidence in favor of expansionary austerity was thoroughly debunked.

And now we’re watching Econ 101 in the process of being confirmed. I wish I thought this would change anyone’s mind.

For many of the Very Serious People on the austerity bandwagon, tax increases that reduce the deficit are a bad idea, they think taxes should be even lower, it's spending cuts they are after. That tells us that the true agenda is something other than reducing the deficit or calling confidence fairies to stimulate the economy. The fairies are mythical, and so is the idea that the true goal is reducing the deficit. The deficit is just the means to an end of smaller government, social insurance in particular -- that's why tax increases that reduce the deficit aren't supported -- and if a slower recovery, higher unemployemt, and more insecurity (for others of course) is the price of reaching that goal, so be it.

    Posted by on Wednesday, April 27, 2011 at 08:01 AM in Budget Deficit, Economics | Permalink  Comments (55)


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