Fiscal austerity damages growth – latest evidence

Republican Presidential (Bush) and Presidential hopeful (Romney) advisor and a principal deficit terrorist, Glenn Hubbard has once again re-cycled his obsession about the apparent necessity for the US to pass a balanced budget amendment which would require governments to eschew their fiscal responsibility and behave like automatums irrespective of the state of the cycle or the behaviour of the other sectors (external and private domestic). In his latest New York Times article (August 11, 2013) – Republicans and Democrats Both Miscalculated – (with T. Kane), we see a tired conservative hack, worn out from repeated failed attempts to push a balanced budget amendment into US law, wimpering about the need for another vote on this issue, but signifying a boring lameness that is being overtaken by the duration of time that has elapsed without the doomsday arriving and more recent evidence refuting the position outright.

If I was Dr Hubbard and the New York Times I would just agree to republish the same article over and over again and just update some dates.

He is a worn out record. Always wrong and never varying in his wrongness. I thought intelligent life adapted.

For example, in his 2010 New York Times article (November 15, 2010) – Left, Right and Wrong on Taxes – he was extolling the virtues of the Bowles and Simpson deficit reduction plans and claimed that “America’s fiscal mess is real”.

In this article he was advocating cuts in higher marginal tax rates in an overall framework of deliberate reductions in the budget deficit – so cutting spending – as a growth strategy which would also make America fairer. Go figure, given that austerity kills growth and inequity tends to rise in downturns.

One of his remarks that underlies everything he ever writes was once again repeated in this article:

… we are in a difficult situation in large part because we have designed entitlements for a welfare state we cannot afford.

There was no attempt in the article (or anything he has ever written) to make a case that the US will run out of real resources such that standards of living for pensioners will have to fall because there won’t be sufficient goods and services available.

His argument is always in terms of the US government running out of money and defaulting on pension payments. That will never happen unless the politicians pass a law which obliges them to do something stupid like that.

Short of that sort of madness, the US government will always be able to send pension cheques out.

Whether that maintains the expected real standards of living is another issue and depends on the future productivity of the US and the willingness of foreigners to offer goods and services to Americans in addition to the output that the US produces domestically.

What we do now is that productivity does not grow strongly when the economy is labouring under deficient aggregate demand.

Further, austerity is meant to reduce the burden in our children (flawed reasoning based on a view that deficits are always paid back in higher taxes), the reality is that austerity creates sluggish growth, if not recession, rising unemployment, which impacts disproportionately on young workers and school leavers and denies them the chance to gain essential workforce skills and experience.

The result of that? Lower future productivity and lower real standards of living for the pensioners.

So the very solutions to the non-problem that the deficit terrorists propose actually ensure the non-problem becomes a major problem.

A few days after the New York Times article came out, Joe Klein wrote in the Time Magazine article (November 18, 2010) – Obsessed with the Deficit – and Ignoring the Economic Mess – that:

This is the same Glenn Hubbard who served as George W. Bush’s chief economic adviser when Dick Cheney was saying that “Reagan proved deficits don’t matter.” One imagines that if Hubbard was so concerned about deficits, he might have resigned in protest from an Administration dedicated to creating them. But, no, he’s here to speak truth to the powerless – to the middle-class folks whose major asset, their home, was trashed by financial speculators, thereby wrecking their retirement plans and creating the consumer implosion we’re now suffering. Hubbard is telling them they now have to take yet another hit, on their old-age pensions and health insurance, for the greater good.

The word hypocrite comes to one’s lips.

Anyway, as noted above, Hubbard was at it again yesterday – again in the New York Times. He acknowledges that the previous “strategy” of conservatives, referred to as the “starve the beast” approach – has largely failed and a new approach is required to eliminate budget deficits.

The starve the beast strategy goes back to the days of Ronald Reagan when Dave Stockman thought he was a genius by devising what he thought was a devilishly clever strategy whereby the government would cut taxes and run the budget deficit up and then after people were used to the lower tax regime, the government would have political support to introduce massive spending cuts.

That way, the Republican dream of small government would be achieved.

The problem was that it didn’t work. According to Hubbard, deficits might:

… strike fear in the hearts of economists and intellectuals, but they don’t matter at the ballot box. Jobs matter. Growth rates matter. Wars matter. Deficits? Yawn.

Which for someone who claims to be an advocate for freedom should tell him that people see no issue and care about real things. I found this dissonance interesting. Apparently the “economists and intellectuals” know better.

I think he was using the word intellectual rather liberally. The deficit terrorist rabble in the US who pump out propaganda on the back of billions of funding from a few wealthy US citizens, many of them who gained that wealth on the back the financial market deregulation they lobbied for, could hardly be described as intellectuals.

There is a quality about an intellectual that passes these characters by.

Anyway, those who wanted to starve the beast misread the electorate and governments have responded with higher deficits. Hubbard says the “Conservatives were wrong — not in beliefs that higher marginal tax rates harm growth, not that debt is dangerous, but about strategy. The beast was not starved”.

One would surmise that after 30 years the public would have some views about the matter. Hubbard is implying that the electorate do not know what is best for them, which is a very curious position for a conservative, who by definition prioritises the rationality of the individual, to take.

What can be done? have another go at passing a balanced budget amendment, which would force the government of the day to follow a highly restrictive fiscal rule on the spending side (“Congress shall spend no more in the current year than it
collected, on average, over the previous seven years”).

There is no rationale given for that proposal – these sort of articles assume away the debate – which should focus on the role of the deficit – and instead start from the claim that deficits are bad so how to eliminate them.

Even progressives use language that suggest that reducing deficits is a movement in the right direction, which is as moronic as the balanced budget rule approach.

So Hubbard wants spending cuts to “balance the beast” but concluded with this:

America’s high and rising national debt threatens our economic health through higher future taxes, crowding out important government services, or both. The best antidote is a focus on economic growth and a balanced approach to deficit control.

Which is about as wimpish as it gets. When have these future taxes ever been levied to pay back debt? Apparently, the crowding out argument has morphed into deficits now crowding out government spending. What?

And we want growth and deficit control – but he fails to provide an explanation how growth, which leads to deficit reduction anyway, would be consistent with a balancing of the beast – that is a balanced budget via expenditure cuts.

Glenn Hubbard might read two articles. One published in 1996 and one recently published. He might learn a few things and realise that people have actually examined the sort of nonsense that he pushes out into the public debate and found the propositions wanting – like seriously wrong.

The earlier article (thanks to Stephanie for reminding us of it) was published by Frederick C. Thayer from American Journal of Economics and Sociology in 1996. It was earlier published as an Op Ed article in the Washington Spectator (January 1, 1996, pp.2-3).

The paper is available – HERE

[Reference: Thayer, F.C. (1996) ‘Balanced Budgets and Depressions’, American Journal of Economics and Sociology, 55(2), 211-12]

The article is the evidential basis for statements you will hear from Modern Monetary Theory (MMT) presenters over the last 15 years that every time the US government runs a surplus, a recession has followed soon after.

It is a very hard hitting 2 pages and I wish I could write as succinctly.

I first read the paper soon after it was published and was impressed by Frederick Thayer’s documentation of what he called:

… the consistently startling historical record.

He documents 6 depressions – 1817-21; 1823-36; 1852-57; 1867-73; 1880-93; and 1920-30 – as “significant economic depressions among the innumerable ‘business cycles'”.

He demonstrates that:

Each sustained period of budget-balancing was immediately followed by a significant depression. There are as yet no exceptions to this historical pattern.

The message from this analysis is clear. As Frederick Thayer notes:

… if the market for consumer goods cannot do the job, there is every reason to turn to the production of public goods, always in short supply anyway.

Which tells us that spending creates income – $-for-$. There is a certain amount of spending in any particular period that is required to fully employ the willing and available labour force.

There are only three sectors that can provide that spending: private domestic, external, government.

If there is an external drain (via a current account deficit) on spending, and the private sector reduces its spending, then the only way the economy can avoid an economic downturn (leading to recession) is for the government sector to fill the gap.

That is inescapable but ignored by the likes of Glenn Hubbard when they launch their irrational rants about debt and deficits.

Thayer says that the deficit terrorists “write about the desirability of reducing national debt … but do not mention “depression” in the same breath” because “it is helpful to the maintenance of economic myth to say little about depression in textbooks” etc.

Thayer’s conclusion is worth documenting:

The tragicomedy of economics is easily displayed. If someone borrows money to build a brewery, the money is officially listed as “investment” in national income accounts. If government borrows money to build a bridge that is needed by the brewery, these funds are not listed as “investment” because the bridge is considered “waste”. To think that this sort of logic undergirds public policy is to experience pure fright. Economics, of course, is not the only “discipline” that fill the world with unsupportable myths, but it is among the leaders.


You might then say – but what about the recent studies by Alesina and Ardagna (2010) and less recent, Alesina and Perotti (1995) – didn’t they find that when austerity is imposed growth increases?

[References: Alesina, A, and Perotti, R. (1995) ‘Fiscal Expansions and Adjustments in OECD Economies’, Economic Policy, 10(21), 207-247.

Alesina, A, and Ardagna, S. (2010) ‘Large Changes in Fiscal Policy: Taxes versus Spending’, in J.R. Brown (ed), In Tax Policy and the Economy, 24, Chicago: University of Chicago Press, 35-68]

They did find that albeit in a qualified manner. But a very nice piece of work that has just been made public – The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy’ – finds these works to be deficient in technique and research design and when correct techniques are deployed the results do not support the view that austerity is good for growth.

[Reference: Jordà, Ò and Taylor, A.M. (2013) ‘The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy’, Paper presented at the NBER Summer Institute]

A summary of the paper – with the technical aspects watered down for public consumption is found here – When is the time for austerity? .

I will leave it to you to read the details. It is a technical paper but relatively easy to follow.

The main conclusions are:

1. Fiscal “austerity has a mostly negative effect, all years” in times of boom and weak demand and “it has larger and more statistically significant negative effects in the slump”. In booms, the negative impact is “smaller (and mostly statistically insignificant)”.

2. There is strong “evidence of contractionary austerity in the weak economy with much more precise estimates. These results suggest that only a strong economy can bear a fiscal consolidation without significant output losses”.

And, of-course, when the economy is strong and pushing up against the inflation barrier, fiscal cutbacks may be appropriate.

3. Their “conservative” estimate of the effect of austerity in the UK is that fiscal austerity has reduced real GDP by about 60% on where it would have been if the recovery path that began in 2009 had not been disturbed. They conclude that “(w)ithout austerity, UK real output would now be steadily climbing above its 2007 peak, rather than being stuck 2% below”.

4. They conclude that “Keynes is still right, after all” and quote Keynes as follows:

The boom, not the slump, is the right time for austerity at the Treasury.


This is a very powerful paper and obviously not at all surprising.

I didn’t see it getting headlines today in the New York Times. They prefer to publish the ravings of Glenn Hubbard who should pause for a moment, step down from his pulpit and consult the evidence.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

This Post Has 6 Comments

  1. Watch Dr Hubbard being interviewed on ‘Inside Job’ and you will learn as much as you need to know about this gentleman.

  2. I cannot believe how hard people find it to grasp that there is no escape from the sectorial balances, because it somehow clashes with their political beliefs that the economy can be, and should be, run like a household. I point out that it is just a fact of mathematics, it’s nothing to do with politics, it just is. You, Mr Mitchell, are of course a left wing firebrand rabble rouser because you have read Marx and believe that trade unions have an important role in national life.

    I have always found this blog politically neutral and equally critical of economic policy when it’s wrong whoever the party is in any country. I wonder if you read the quite pathetic defence of Rogoff and Reinhart in the UK Guardian?

    Any argument you like is fine as long as it’s classical mainstream and the only choices are Friedman or Keynes.

  3. This statement confused me:

    ” If government borrows money to build a bridge that is needed by the brewery, these funds are not listed as “investment” because the bridge is considered “waste”.”

    I thought public investment is treated the same way as private investment in the national accounts, i.e. in a closed economy with no private investment public investment would equal national saving even if entirely debt financed.

  4. Not quite on topic but John Lanchester has written a couple of good journalistic articles on British banks in the London Review of Books recently. Stunning figures quoted by him from British Chancellor of the Exchequer showing that the ONLY growth in the British economy was due to the fines levied on the banks because of their insurance fraud. That is money coming out of the banks into the “real” economy was the growth stimulant and none of the billions poured into the banks added anything

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