British Austerity: Point/Counterpoint

Paul Krugman is triumphant on the failure of Britain’s austerity:

Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.

Nor is Britain unique. Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.

And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.

Not so fast says Scott Sumner:

But I am seeing article after article claiming that the coming recession is due to fiscal tightening. I was curious to see just how tight British fiscal policy actually is, so I checked the “Economic and Financial indicators” section at the back of a recent issue of The Economist. They list indicators for 44 countries, including virtually all of the important economies in the world. Here are the three biggest budget deficits of 2011:

1. Egypt 10% of GDP

2. Greece: 9.5% of GDP

3. Britain: 8.8% of GDP

Egypt was thrown into turmoil by a revolution in early 2011. Greece is, well, we all know about Greece. And then there’s Great Britain, third biggest deficit in the world.

I suppose some Keynesians work backward, if there is a demand problem it must, ipso facto, be due to lack of fiscal stimulus. If the deficit is third largest in the world, it should have been second largest, or first largest.

A slightly more respectable argument is that the current deficit is slightly smaller than in 2010 (when it was 10.1% of GDP.) But that shouldn’t cause a recession. Think about the Keynesian model you studied in school. If you are three years into a recession, and you slightly reduce the deficit to still astronomical levels, is that supposed to cause another recession? That’s not the model I studied. Deficits were supposed to provide a temporary boost to get you out of a recession. At worst, you’d expect a slowdown in growth.

To cast a slightly broader net on the austerity which European countries are practicing the only two in which something that meets the intuitive definition of austerity are Sweden where the budget is balanced and Switzerland which is running a fiscal surplus of 1% of GDP. Sweden’s GDP growth rate is about 5.5%; its unemployment rate is 7.4%. Switzerland’s GDP growth rate is 2.6% (roughly the same as ours); its unemployment rate is 3.3%.

My point is not that austerity works. I have two points:

  1. Whatever Greece and Britain are doing, it’s not austerity.
  2. There’s no obvious, simple, straight line connection between fiscal policy and growth. In either direction.
12 comments… add one
  • If John Persona/Odograph were to see this post Dave he’d throw a fit and fall in it.

  • Since jp likes to compare everything with Denmark, in his honor I note that Denmark’s fiscal deficit is 3.9% of GDP, its GDP growth rate is 2.1%, and its unemployment rate 6%. And it doesn’t belong to the EMU. My tentative conclusion from all of this is that lots of trade with Germany is good as long as you don’t use the same currency that Germany does. I also note that using the rule-of-thumb known as “Okun’s Law” (3 points faster increase in GDP = 1 point less in unemployment) Denmark might just possibly be able to reduce its unemployment rate a bit but Sweden’s lowering its unemployment rate looks pretty unlikely.

    Frankly, I think he’d be more upset about my earlier post this morning on trend-spotting. If potential real GDP is hooey (which I think it is generally but especially under the present circumstances) then there is no such thing as an output gap.

  • Icepick Link

    Clearly, by Krugman’s reasoning, Italy and Spain should return to their policies of the 1930s.

  • Icepick Link

    Krugman’s comparisons to the Great Depression remind me of something I’ve been meaning to ask. I keep being told that Obama has saved us from another Depression. (Mainly by not stopping various Bush programs, it seems, such as the bank bailouts, but that never gets mentioned.) How do we know that? The Great Depression is usually thought of as the entirety of the 1930s. But for most of the 1930s the economy was in recovery mode. Given that UE still sucks (despite the blatantly cooked stats of the Obama Adminsitration) and the median income is still down, food stamp usage continues to go up, food banks are still under pressure, etc., why shouldn’t we believe that we’re still deep in the shit?

  • PD Shaw Link

    Icepick, particularly since I believe the Great Depression left us with stabilizers like federal deposit insurance and unemployment insurance that probably should be credited with lessening future similar economic downturns. Perhaps the Great Depression saved us from another Great Depression.

  • I keep being told that Obama has saved us from another Depression.

    Although they all take credit for whatever good happens on their watches and blame everything bad on their predecessors, I think that presidents and administrations don’t actually have a great deal of influence on the economy. IMO giving the Pelosi Congress its head diluted whatever impact the stimulus package might have had and, as you note, otherwise the Obama Adminstration has largely followed the Bush Administration’s lead.

    I’ve already given my opinion: I think we should have devoted more attention to the handful of states that had the greatest problems rather than trying to deal with the economic downturn as a 50 state problem. That would have required more leadership.

  • The Great Depression is usually thought of as the entirety of the 1930s. But for most of the 1930s the economy was in recovery mode.

    The Great Depression is actually 2 recessions and the first one was a bad one at that. Very bad.

    While many look at the stock market crash that is unlikely as the single driver. What likely played a larger role was the tightening of monetary policy and sticking with the Gold Standard. Many countries that went of the Gold Standard (e.g. the UK) got off much lighter than those countries that stuck it out longer (e.g. the US).

    The much ballyhooed legislation and notions of FDR nearly killed the resulting expansion. Growth after going off the Gold standard was very strong. But then FDRs policies were decidedly anti-competition and resulted in reductions in output, employment, and a decrease in economic activity.

    Once that stopped growth picked up again, but unemployment was decidedly anemic for quite sometime afterwards.

    Check out this post, scroll down to the graphs, especially output. It seems pretty clear…FDR extended the Great Depression.

  • Icepick Link

    Perhaps the Great Depression saved us from another Great Depression.

    This is an excellent point.

  • Drew Link

    What likely played a larger role was the tightening of monetary policy and sticking with the Gold Standard.

    Letting out the inner Friedman and Schwartz…….


  • Ben Wolf Link

    Britain has raised taxes and cut spending sufficiently that the private sector is hemhorraging. Every time I see an “analysis” of the failure of deficits to return a country to economic growth, it invariably fails to take into account the rate at which money is flowing OUT of the private sector.

    Fully a quarter of the UK’s deficit is consumed just making up for the financial leakage from its current account deficit and the 20% increase in VAT is the definition of pro-cyclical policy depressing consumer spending. The U.S. CAD last year was nearly $600 billion: assuming very generously that half makes it back into our economy as the owners of the dollars buy U.S. assets, the federal government must spend $300 billion just so the private sector can break even on the CAD. This of course does not include the myriad other financial drains which restrain a rebound in aggregate demand.

  • steve Link

    1) I am not sure that using deficits to measure austerity is meaningful.

    2) I would think that reducing the rate of growth below past projected spending needs would count as some kind of austerity. If, say, your number of retirees were growing by 5%/year, and you reduced pension spending so that it increased by just 1%/year, that should count. I dont buy a need to have cuts in nominal spending as a requirement for austerity. Increasing growth below the rate of inflation would also seem to fit. YMMV.


  • A Benedictine monastery is austere; Diamond Jim Brady spending 10% less on his dinner on Wednesday than he did on Tuesday isn’t. If the word is to mean anything at all it’s got to be related to some basis (like national income) not merely year-on-year differences.

    Call it what it is: spending reduction. Or reduction in the expected level of spending. Calling it “austerity” is an appeal to emotions.

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