Should-read: Robert Skidelsky: The advanced economies’ lost decade

Should-Read: The eminent Robert Skidelsky identifies three groups of economists who gave what ex post was clearly bad advice, and bad advice that mattered about fiscal policy, from 2009 on: Alberto Alesina and company with their “expansionary austerity” doctrines, Ken Rogoff and company with their “short-term-pain-for-long-run-gain” doctrines, and Ricardo Haussman and company with the “no choice but austerity” doctrines. All three groups, however, had reasons for their arguments and were thinking hard—albeit, in my view, not as hard and as deeply as they ought to have and had a responsibility to do—and genuinely believed what they were putting forward. There were also three groups of economists giving bad advice who either did not believe what they were saying or had done no thinking at all: Robert Lucas and company with his “nothing to apply a multiplier to” ideological and unfounded claims that fiscal policy could never be effective; John Taylor, Marvin Goodfriend, and company with their Bernanke’s monetary expansion will produce currency debasement and inflation but will not boost employment; and a whole host of professional Republicans who ought to have been backing up Bernanke’s plans for further monetary stimulus and his call for an end to fiscal austerity headwinds, but were instead very quiet, as Elmer Fudd would say, in part at least not to annoy political masters in the Republican Party. I think the economics profession could have played a useful role in helping to manage the recovery if those three groups unmentioned by Skidelsky had not been present. Those of us whom Skidelsky identifies, correctly, as having gotten the big picture right from 2009-present could have won the argument with Alesina and company, Rogoff and company, and Haussman and company. Indeed, we did. Ricardo Haussman now acknowledges the crucial role played by monetary régime in the determination of fiscal space. Ken Rogoff recognizes that there is no cliff at which growth falls sharply and discontinuously when the debt to annual GDP ratio exceeds 90%. Alberto Alesina recognizes the necessity of proper support from monetary and exchange rate policy if fiscal contraction is not to be expansionary. We could have won those debates, and won them in a timely fashion. But we could not carry the field when faced not just with our good faith but our bad faith opponents: whether actively purveying misinformation, lazily not thinking, or sulking in their tents like Akhilleus on a bad day, they put enough sand into the gears so that my profession failed to do its job as the memory and planning department of the human race. I am kinda surprised they show themselves in polite company: Robert Skidelsky: The Advanced Economies’ Lost Decade: “Policy interventions immediately following the 2008 crash did make a difference…. The 2008 collapse was as steep as that of 1929, but it lasted for a much shorter time…

…The 2008 crisis was met not by belt-tightening, but by globally coordinated monetary and fiscal expansions, particularly on the part of China. As J. Bradford DeLong of the University of California, Berkeley, notes, “The aftermath of the 2007-2008 financial crash was painful, to be sure; but it did not become a repeat of the Great Depression, in terms of falling output and employment.” Within four quarters, “green shoots” of recovery were appearing; that didn’t happen for 13 quarters after the 1929 crash. Yet in 2010… OECD governments rolled back their stimulus policies and introduced austerity policies, or “fiscal consolidation,” designed to eliminate deficits and put debt/GDP ratios on a “declining path”… slowed down the recovery, and probably reduced the advanced economies’ productive capacity as well. In Europe, Stiglitz observed in 2014, the period of austerity had “been an utter and unmitigated disaster.” And in the United States, notes DeLong, “relative performance after the Great Recession [has been] nothing short of appalling.”…

Economists vigorously debated the merits of withdrawing stimulus so early in the recovery. Their arguments, which can be broken down into four identifiable positions, open a window onto the role that macroeconomic theory played in the crisis.

Those in the first camp claimed that fiscal austerity–that is, deficit reduction–would accelerate the recovery in the short run…. Alberto Alesina… much in vogue… assuring European finance ministers that “Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run.”… Robert J. Shiller countered… “austerity programs in Europe and elsewhere appear likely to yield disappointing results.”… Jeffrey Frankel pointed out in May 2013 that Alesina’s co-author on two influential papers, Robert Perotti, had recanted, having identified flaws in their methodology. Following more criticism of his methodology by the International Monetary Fund and the OECD, Alesina himself became considerably more circumspect…. Of course, by then, he had already contributed his mite to the sum of human misery….

Those in the second camp countered that austerity would have short-run costs, but argued that it would be worth the long-run benefits…. Out of the Alesina wreckage emerged… “short-run pain for long-run gain.”… The most influential version of the “short-run pain for long-run gain” argument came from Harvard’s Kenneth Rogoff and Carmen M. Reinhart. In their 2009 book, This Time is Different: Eight Centuries of Financial Folly, Rogoff and Reinhart attributed the “vast range of [financial] crises” throughout modern history to “excessive debt accumulation.”… Rogoff claimed that public debt levels above 90% of GDP imposed “stunning” cumulative costs on growth. The implication was clear: only by immediately reducing the growth of public debt could advanced economies avoid prolonged malaise…. As Oscar Wilde wrote of Wordsworth, “He found in stones the sermons he had already hidden there.”… Former British Chancellor George Osborne, who strongly supported reducing the size of the state, credited Reinhart and Rogoff for influencing his thinking….

A third camp, comprising Keynesians, argued unambiguously against austerity…. The Keynesian argument was straightforward. Because the slump had been caused by an increase in private-sector saving, the recovery would have to be driven by government dissaving–deficit spending–to offset the negative impact on aggregate demand. As Mark Blyth of Brown University noted in 2013, the attempt by European governments at the time to increase their savings was having a ruinous effect…. The alternative to austerity–fiscal expansion–would… produce faster economic growth and thus reduce the debt ratio in the medium term…. Fiscal consolidation… reduces the economy’s future productive capacity. When workers experience long-term unemployment… they can fall into a vicious cycle in which they become even less employable with the passage of time. The problem, notes Nouriel Roubini… is that “if workers remain unemployed for too long, they lose their skills and human capital.”… Hysteresis, which helps to explain the decline in the growth rate shown in Figure 1, can also result from a large-scale switch to inferior employment…. I find the Keynesian perspective more intuitively appealing than the Rogoffian one. It stands to reason that long spells of unemployment or inferior employment will undermine a country’s output potential. But to argue that an “abnormal” level of national debt does the same, one must also demonstrate that state spending–whether tax- or bond-financed–hurts long-term growth by reducing the economy’s efficiency. And such a claim relies heavily on ideology….

And the fourth camp maintained that, regardless of whether austerity was right, it was unavoidable, given the situation many countries had created for themselves…. In 2010, the Princeton University historian Harold James pointed out that a country’s creditors can sometimes force it to undergo “fiscal consolidation.” This is particularly true for countries with a fixed exchange rate…. In the early years of the crisis, Greece stood out as an awful warning to others. Ricardo Hausmann of Harvard University notes that, “by 2007, Greece was spending more than 14% of GDP in excess of what it was producing,” with the gap being “mostly fiscal and used for consumption, not investment.” Still, Laura Tyson of the University of California, Berkeley, contends that Europe’s bondholders, led by Germany, conflated Greek public profligacy with private greed and myopia. Expanding on this point, Simon Johnson of MIT observed that while debtor countries suffered dearly for over-borrowing, banks faced almost no penalties for over-lending. Many discussions about the feasibility of different fiscal policies revolve around the mysterious idea of “fiscal space.”…

In the US, the UK, and the eurozone (after March 2015), economic policymakers sought to offset fiscal contraction with monetary expansion, chiefly by purchasing massive quantities of government bonds. The consensus view is that QE was modestly successful, but fell far short of fulfilling monetary policymakers’ goals. Central bankers had assumed, incorrectly, that if they simply printed money, it would automatically enter the spending stream. This faulty theory of money was driven by pure ideology, as the Nobel laureate economist Robert E. Lucas, Jr., unwittingly intimated in a December 2008 Wall Street Journal commentary. Unlike fiscal expansion, Lucas observed, monetary expansion “entails no new government enterprises, no government equity in private enterprises, no price fixing or other controls on the operation of individual business, and no government role in the allocation of capital across different activities.” In his view, these are all “important virtues”–which is to say, a faulty theory is better than one that entails any increased role for the state.   

All told, I believe the policies since the financial crisis have extended the damage of the slump itself. Looking ahead, we will have to confront not just the problem of waste or missed opportunities, but of regression. We are restarting economic life with dimmer long-term prospects than we otherwise would have had…

April 13, 2018


Brad DeLong
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