Time to Play Whack-a-Mole with the Expansionary-Austerity Confidence-Fairy Zombie Once Again!

Four readings on the expansionary austerity zombie:

Reading #1: Paul Krugman (2015):

Paul Krugman: Views Differ on Shape of Macroeconomics (2015): “The doctrine of expansionary austerity…

…the claim that slashing spending would actually boost demand and employment, because it would have such positive effects on confidence that this would outweigh the direct drag–was immensely popular among policymakers in 2010, as the great turn toward austerity began. But the statistical underpinnings of the doctrine fell apart under scrutiny: the methods Alberto Alesina used to identify changes in fiscal policy did not, it turned out, do a very good job, and more careful work found that historically austerity has in fact been contractionary after all. Moreover, the experience of austerity programs seemed to confirm what Keynesians new and old had warned from the beginning–that the negative effects of austerity are much larger under conditions where they cannot be offset by conventional monetary policy. So at this point research economists overwhelmingly believe that austerity is contractionary (and that stimulus is expansionary)…. For now at least expansionary austerity has virtually collapsed as a doctrine taken seriously by researchers. Nonetheless, Simon Wren-Lewis points us to Robert Peston of the BBC declaring

I am simply pointing out that there is a debate here (though Krugman, Wren-Lewis and Portes are utterly persuaded they’ve won this match–and take the somewhat patronising view that voters who think differently are ignorant sheep led astray by a malign or blinkered media).

Wow. Yes, I suppose that ‘there is a debate’ — there are debates about lots of things, from climate change to evolution to alien spaceships hidden in Area 51. But to suggest that this debate is at all symmetric is just wrong — and deeply misleading to one’s audience. As for the claim that it’s somehow patronizing to suggest that voters are ill-informed when (a) macroeconomics is a technical subject, and (b) the media have indeed misreported the state of the professional debate — well, this is sort of an economic version of the line that one must not suggest that the Iraq war was launched on false pretenses, because this would be disrespectful to the troops. If you’re being accused of misleading reporting, it’s hardly a defense to say that the public believed your misinformation — more like a self-indictment…

The question to which “expansionary austerity” was relevant was never: can one substantially reduce the budget deficit without risking substantial recession? The answer to that was always yes: if fiscal contraction is supported by monetary expansion a outrance the decline in government purchases from spending reductions and in consumption spending from tax increases can be offset and more than offset by higher exports and higher investment spending. That is and has been standard Keynesian doctrine since the 1950s, at least. (Cf. the Economic Report of the President chapter that Robert Solow drafted in the early 1960s.)

The novelty of Alesina’s claim was not that monetary offset can neutralize the short-run contractionary effect of fiscal austerity. It was, rather, that summoning the Confidence Fairy could and many times had neutralized the short-run contractionary effect of fiscal austerity.

The question to which “expansionary austerity” purported to give the answer was: At the zero lower bound, where attempts to stimulate the economy through expansionary monetary policy have greatly reduced traction and are fraught, is the connection between lower deficits and more optimistic business animal spirits strong enough that one can one substantially reduce the budget deficit without risking substantial recession?

And back in 2010 Alberto Alesina very strongly said that the answer to that was “yes”: Reading #2:

Alberto Alesina: Fiscal Adjustments: Lessons from Recent History

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. These are the adjustments which have occurred on the spending side and have been large, credible and decisive…. Governments which have initiated thorough and successful fiscal adjustment policies have not systematically suffered at the polls… especially… when the electorate has perceived the sense of urgency of a crisis or in some cases in the presence of an external commitment. On the contrary, fiscally-loose governments have suffered losses at the polls…. Thus relatively painless (economically and politically) fiscal adjustments might be possible; whether government will take the opportunity remains to be seen…

“Many” and “even sharp” have been “immediately followed” because adjustments that “have been large, credible and decisive” and “have occurred on the spending side” have summoned the Confidence Fairy. Thus governments should “take the opportunity” for the “relatively painless (economically and politically) fiscal adjustments” that “might be possible” via expansionary austerity.

This was pretty much completely wrong. Many of Alesina’s adjustments were not policy adjustments at all–but rather unplanned side-effects of booms driven by other factors. The rest appeared, to me at least, to be due to the kind of expansionary monetary policy offset that the Clinton administration had planned and carried out over 1993-6 and that was not possible at the zero lower bound.

Nevertheless, it appears that Alesina is sticking to his guns here: Reading #3:

Alberto Alesina (2016) Fiscal Policy and Austerity: “Well, I think Paul Krugman has rather extreme views…

…But more importantly, he talks about his views as if they were obviously true, and anybody who would disagree with him was obviously wrong. And he exaggerates. And that I really prefer not to go into a discussion about his quotes.

But I think that the idea that the work about austerity that I and others have done has been discredited is wrong. In fact, the IMF, in 2010 wrote a rather pointed criticism about my work…. [The IMF’s] second point is whether whether there are cases where spending cuts accompanied by other policies can be expansionary, and the confidence argument that he makes fun of is actually confidence, one of the many aspects; and we can elaborate on that. But I think that there are several episodes in which fiscal spending cuts have been accompanied not by a recession, but by an expansion. So, I think that those kind of statements by Krugman are trying to push a view which is respectable but they are not proven by the facts. Or at least they are not supported by research….

I do think that confidence is important, because we have empirical evidence suggesting that when there are spending cuts, the confidence of investors actually goes up, and the confidence of consumers goes down very little; while with tax increases, confidence of both consumers and business investors goes down quite a bit in many countries. So confidence has played a role. And then, there are many–as I said, austerity plans are a combination of many, many other policies. So, it matters what monetary policy does. It matters that sometimes, particularly in European countries, when there is a crisis and austerity is called for, then there is a productive opportunity to engage in other so-called “structural reform”–labor market reform and goods market reform, liberalization of various sectors, which help and that indeed has spurred growth. And of course monetary policy matters–we are saying in a situation which monetary policy is supportive and expansionary, that helps fiscal adjustment. So these are just the more important of many other factors which are left out from the basic Keynesian model…

My view: Alberto should simply not be saying this. If you want to claim that the Confidence Fairy channel–rather than the monetary offset channel–is important, you bring forward at least one regression or at least one case study in which a sharp, large, credible, and decisive policy of fiscal austerity has been rapidly followed by a substantial improvement in business confidence which then immediately drives sustained growth. If you don’t have that regression or that channel–if what you have is monetary-policy offset plus misspecification of your right hand-side variable–you do not have an economic argument.

Reading #4:

Franklin Delano Roosevelt (1933): First Inaugural Address: “our distress comes from no failure of substance. We are stricken by no plague of locusts…

…Compared with the perils which our forefathers conquered because they believed and were not afraid, we have still much to be thankful for. Nature still offers her bounty and human efforts have multiplied it. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply. Primarily this is because rulers of the exchange of mankind’s goods have failed through their own stubbornness and their own incompetence, have admitted their failure, and have abdicated…. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish…

June 28, 2016


Brad DeLong
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