The case for austerity, and our case
In recent months, economist Alberto Alesina has become popular among conservatives for research showing that deficit reduction can sometimes be accompanied by economic growth; that spending cuts are better than tax cuts; and for arguing that stimulus is less effective than Keynesians think and thus spending cuts can begin now. Business Week's Peter Coy is skeptical:
Alesina's historical research, though, doesn't shed much light on what might happen if the U.S. adopts an austerity budget, because current circumstances don't resemble most of those in Alesina's database. It's rare for a nation to suffer such a big shortfall in demand that it cuts interest rates to zero, as the U.S. has. It's even rarer for a government in such circumstances to tighten its fiscal belt. Japan's experience is a cautionary tale. Japan attempted to tackle its deficit in the late 1990s during a period of weak demand and near-zero rates. Many economists say the move prolonged the slump that became known as Japan's Lost Decade. To be sure, Japan tried to balance its budget mainly by raising taxes, which is not Alesina's preferred solution.
Economists who describe themselves as Keynesians or neo-Keynesians don't buy Alesina's medicine. Gauti B. Eggertsson, a staff economist at the Federal Reserve Bank of New York, concluded in a paper last November that, with interest rates at zero, the right remedy is to raise government spending, not cut it. Espousing his own views and not those of the Fed, Eggertsson wrote that when extremely loose monetary policy isn't stimulative enough, "the goal of policy should be to increase aggregate demand -- the overall level of spending in the economy."
Alesina's own research shows mixed results from deficit-cutting. He identified 26 examples since 1980 of deficit reductions that triggered growth of gross domestic product and 21 that lowered government debt substantially. He found only nine double victories in which government policymakers managed both to expand their economies and reduce debt. (Among them: Ireland in 2000, and the Netherlands and Norway in 2006).
To argue with myself for a moment, this is one of the difficulties with analysis. Fairly few political commentators know enough to decide which research papers are methodologically convincing and which aren't. So we often end up touting the papers that sound right, and the papers that sound right are, unsurprisingly, the ones that accord most closely with our view of the world. So Alesina's paper gets a lot of conservative pickup, but if it had found the opposite, it would've been ignored by conservatives, or maybe torn apart by experts sympathetic to the conservative approach to austerity, even as liberals championed its findings.
That said, even as a matter of simple logic, I really don't understand the case for why a business would begin spending if the government announces major cuts this year. So the government says, "I'm going to take demand out of the market, end tax cuts that are helping people spend, throw a large number of public employees out of work, and reduce the spending power of the unemployed." And it's in that context that, say, a manufacturer of picture frames, or a local coffee chain, decides to hire more people? Where is the promise of further demand?
July 7, 2010; 9:00 AM ET
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