Wednesday, 15 May 2013


This blog-post is in reaction to two letters from John Mauldin and a blog-post by Noah Smith who has gotten some well-deserved attention.

The theme linking these three articles is whether there is a justification for austerity right now and what it might be.

After all, we are clearly far from full employment and inflation has turned out to be no threat (you can add 'so far' if you are one of those who refuse to admit that fears about bond vigilantes and hyperinflation were wrong).

Why not follow Krugman's policy recommendation? The poor man is losing his voice repeating himself week after week. Or we could try and follow Sumner's ideas and, like Japan, carry out  an (even more?) massive monetary stimulus.

But some people are dead-set against either solutions.

Noah Smith: "What unites all these and other "austerians"? There are several possibilities. One is that austerity is a good idea (...) Another is that these are political conservatives who are worried that counter-cyclical macroeconomic policy will redistribute income and regulatory privilege away from themselves or their favored social groups. A third is that the psychological impulse toward austerity - tighten your belt in bad times! - is simply very very strong among all humans. And a fourth possibility, favored by Paul Krugman, is the idea that austerity is perceived as morally virtuous.

I want to suggest a fifth possibility. I conjecture that "austerians" are concerned that anti-recessionary macro policy will allow a country to "muddle through" a crisis without improving its institutions. In other words, they fear that a successful stimulus would be wasting a good crisis".

John Mauldin, as far as I know, coined the term 'muddle through economy' in 2002, if I recall correctly. So it's only fitting to turn to him to see what 'austerians' might reply to someone like Noah Smith.

In a recent piece about  Ken Rogoff and Carmen Reinhart (R&R), Mauldin answers Noah's criticism rather directly:

"They (R&R) did make an unfortunate error in a few cells of a massive Excel spreadsheet, which subsequent analysis has shown to not be a huge deal,  though some have made it out to be. And the more I read of the issue, the more I believe that the bulk of the negative response has political overtones. There are those who wish to find reasons to abandon any move toward balanced budgets and reasonable fiscal policies. They see austerity as a punishment, some type of masochistic conservative Calvinist plot foisted on poor unsuspecting citizens (emphasis mine) who should not be held responsible for the governments they elect".

... and, in another article, "Austerity is a consequence, not a punishment", John explains why austerity is NOT a Calvinist plot or a tool for prolonging the crisis till structural reforms are carried but simple maths:

"Austerity has come to have a rather bad name of late. The complaint is that it just doesn't work. Which is somewhat like complaining that the roof is leaking because someone else hasn't fixed it. If by “working” we mean that austerity is supposed to produce growth, then of course it doesn't work. By definition, austerity means you are reducing a fiscal deficit, and doing so will reduce growth in the short term. (Emphasis mine: It's good to see a conservative at least recognizing this point and not trying to pretend that austerity will generate growth through generating greater business confidence).

The governments of the developed world amassed huge sovereign debts in the course of what is known as the Debt Supercycle. As interest rates fell, borrowing to finance consumption and spending became easy. But now that decades-long supercycle has ended.

You can almost hear the critics wanting to dismiss Rogoff and Reinhart’s entire book, which clearly establishes the link between excessive debt and sovereign debt crises – a pattern that has played out some 266 times over the last few centuries, if I remember correctly. The point is that there is no magic number that says “This far and no farther.” There is a mythical line where confidence and trust is lost, but no one knows where that line of demarcation is until it is crossed.

If politicians want to keep the borrow-and-spend party going “just one more election cycle” and if no one takes away the punch-bowl, the Bang! moment will most certainly arrive. That is the clear lesson of history. It is almost irrelevant whether that number is 90% or 120% or 80%. It will be a different number for each country, depending on the confidence that investors have in the ability of a country to pay back its debt. Investors in sovereign debt are almost by definition the most risk-averse investors there are. You do not invest in a country’s debt to increase your risk exposure; you expect to get paid".

John Mauldin does go on to distinguish between countries with their own currency and those that don't but, since he was responding to an Italian reader, the conversation moves to the specifics of Italy and the EU. In short, John states that Italy cannot print money independently, cannot exit the Euro without massive suffering and cannot expect its partners to agree to finance or monetize Italian deficits forever, though he affirms - but not truly explains why - that such monetization is a bad idea anyhow even for monetarily independent countries.

So, do we have a concise conservative rebuttal of Noah's argument? (Quite apart the fact that John Mauldin's reasonable sounding message is clearly undermined - and Noah's   vindicated - by other, less astute or more politically motivated, conservatives)



First, because, as Antonio Fatas points out in an article on his blog, there is a difference between the short-term and the long-term and, though they are not independent, there is no reason not to carry out short-term stimulus and macro-stabilization while fixing (or trying to) the long-term structural issues that might lower the potential for growth of a country.

To quote: "It is possible that irresponsible behavior, excessive spending and accumulation of debt (private or public) are the cause of the Great Recession. And if this is true, it will require future adjustments to spending plans, deleveraging, and fiscal discipline to avoid a repetition of this event in the future. 

But once the crisis started we are dealing with a second problem: a recession that moves us away from full employment. This is a cyclical phenomenon that is well described in macroeconomic textbooks and to deal with it we use monetary and fiscal policy.

The fact that potentially debt and excessive spending were the cause of this cyclical event does not mean that we need to deal with these imbalances now to get out of the crisis. We are dealing with two separate phenomena that are only related because one possibly led to the second one, but the dynamics associated with each of them are very different and the recipe to get out of them can be, in some cases, the opposite".

But I would add a second reason.

And that is that John Mauldin's math is off, for at least two reasons.

It is true that some countries may be running deficits too large for comfort. But curtailing short term growth will only make their Debt-to-GDP ratios worse, not better.

File:Greek debt and EU average.pngFile:Irish debt and EU average.png

The truth is that austerity can damage growth a lot faster than it can reduces debt.

So it's hard to argue that 'austerity' is just a painful medicine countries need to take, just like over-leveraged individuals or companies may need to.

Finally, at least in the USA, deficits are looking more and more under control for at least the coming decade. The CBO had a recent update and it got wide attention.

Sure, as I mentioned before, you can still try and scare the little children with dire projections for the long-long-term.

But the reality is that, with health care inflation is slowing down fast and the longer-term impact of technology and institutional reform unclear or even unknowable, it's absolutely silly to panic over it NOW NOW NOW!

By all means, we have to remain careful and the USA could only benefit from further reforms to its health care markets with the aim of increasing Supply (rather than just trying to make more Demand solvent) but the reality is that John Mauldin's worry about the USA losing bond investors' confidence or being forced to entirely monetize its deficits is a long way off.

The icing of the cake is MattYglesias' point reminding us that, contrary to what (some) conservatives seem to think, crises do not make painful reforms more acceptable to the polity:

"Like most outside observers, I thought Mario Monti's structural reform program for Italy was a good idea. But it ended in catastrophic failure because Monti was proceeding over a total economic disaster. Contractionary short-term policy didn't boost support for reform, it undermined support for the incumbent."

As any internet denizen, I am wary of bringing the Nazis into any discussion but I think Matt Yglesias is essentially correct. Whatever moralists say about the spiritual benefits of pain, people don't take kindly to never-ending doses of it. Eventually, they vote for a populist promising them a fresh start and a new future. To usually disastrous consequences.