Must-Read: Simon Wren-Lewis: A General Theory of Austerity

Must-Read: Simon Wren-Lewis: A General Theory of Austerity: “I start by making a distinction… between fiscal consolidation, which is a policy decision, and austerity, which is an outcome where that fiscal consolidation leads to an increase in aggregate unemployment…

…Monetary policy can normally stop fiscal consolidation leading to austerity, but cannot when interest rates are stuck near zero…. I say that austerity is nearly always unnecessary… has nothing to do with markets: the Eurozone crisis from 2010 to 2012 was a result of mistakes by the ECB. If a union member’s government debt is not sustainable, there needs to be some form of default (Greece). If it is sustainable, then the central bank should back that government, as the ECB ended up doing with OMT in 2012…. None of this theory is at all new….

That makes the question of why policy makers made the mistake all the more pertinent. One set of arguments point to… austerity as an accident… Greece happened at a time when German orthodoxy was dominant…. [But this] does not explain what happened in the US and UK…. The set of arguments that I think have more force… reflect political opportunism on the political right which is dominated by a ‘small state’ ideology…. [But] how was the economics known since Keynes lost to simplistic household analogies[?]…. [And why] in this recession, but not in earlier economic downturns?… It does not have to be this way…. We cannot be complacent that when the next liquidity trap recession hits the austerity mistake will not be made again…