to follow-up on an article Paul Krugman published a few days ago in the
When I was young and naïve,
I believed that important people took positions based on careful
consideration of the options. Now I know better. Much of what Serious
People believe rests on prejudices, not analysis. And these prejudices
are subject to fads and fashions.
Which brings me to the
subject of today’s column. For the last few months, I and others have
watched, with amazement and horror, the emergence of a consensus in
policy circles in favor of immediate fiscal austerity. That is, somehow
it has become conventional wisdom that now is the time to slash
spending, despite the fact that the world’s major economies remain
conventional wisdom isn’t based on either evidence or careful analysis.
Instead, it rests on what we might charitably call sheer speculation,
and less charitably call figments of the policy elite’s imagination —
specifically, on belief in what I’ve come to think of as the invisible
bond vigilante and the confidence fairy.
vigilantes are investors who pull the plug on governments they perceive
as unable or unwilling to pay their debts. Now there’s no question
that countries can suffer crises of confidence (see Greece, debt of).
But what the advocates of austerity claim is that (a) the bond
vigilantes are about to attack America, and (b) spending anything more
on stimulus will set them off.
What reason do we have to
believe that any of this is true? Yes, America has long-run budget
problems, but what we do on stimulus over the next couple of years has
almost no bearing on our ability to deal with these long-run problems.
As Douglas Elmendorf, the director of the Congressional Budget Office,
recently put it, “There is no intrinsic contradiction between
providing additional fiscal stimulus today, while the unemployment rate
is high and many factories and offices are underused, and imposing
fiscal restraint several years from now, when output and employment
will probably be close to their potential.”
Nonetheless, every few months we’re told that
the bond vigilantes have arrived, and we must impose austerity now now
now to appease them. Three months ago, a slight uptick in long-term
interest rates was greeted with near hysteria: “Debt Fears Send Rates
Up,” was the headline at The Wall Street Journal, although there was no
actual evidence of such fears, and Alan Greenspan pronounced the rise a
“canary in the mine.”
Since then, long-term rates have
plunged again. Far from fleeing U.S. government debt, investors
evidently see it as their safest bet in a stumbling economy. Yet the
advocates of austerity still assure us that bond vigilantes will attack
any day now if we don’t slash spending immediately.
don’t worry: spending cuts may hurt, but the confidence fairy will take
away the pain. “The idea that austerity measures could trigger
stagnation is incorrect,” declared Jean-Claude Trichet, the president of
the European Central Bank, in a recent interview. Why? Because
“confidence-inspiring policies will foster and not hamper economic
What’s the evidence for the belief that fiscal
contraction is actually expansionary, because it improves confidence?
(By the way, this is precisely the doctrine expounded by Herbert Hoover
in 1932.) Well, there have been historical cases of spending cuts and
tax increases followed by economic growth. But as far as I can tell,
every one of those examples proves, on closer examination, to be a case
in which the negative effects of austerity were offset by other
factors, factors not likely to be relevant today. For example,
Ireland’s era of austerity-with-growth in the 1980s depended on a
drastic move from trade deficit to trade surplus, which isn’t a
strategy everyone can pursue at the same time.
And current examples of austerity are
anything but encouraging. Ireland has been a good soldier in this
crisis, grimly implementing savage spending cuts. Its reward has been a
Depression-level slump — and financial markets continue to treat it
as a serious default risk. Other good soldiers, like Latvia and
Estonia, have done even worse — and all three nations have, believe
it or not, had worse slumps in output and employment than Iceland,
which was forced by the sheer scale of its financial crisis to adopt
less orthodox policies.
So the next time you hear
serious-sounding people explaining the need for fiscal austerity, try
to parse their argument. Almost surely, you’ll discover that what
sounds like hardheaded realism actually rests on a foundation of
fantasy, on the belief that invisible vigilantes will punish us if
we’re bad and the confidence fairy will reward us if we’re good. And
real-world policy — policy that will blight the lives of millions of
working families — is being built on that foundation.
Mr. Krugman has been busy lately, appearing on
Charlie Rose, and on Sunday he took part in the roundtable
discussion on ABC's This Week, discussing the jobless recovery and
why he was correct that more stimulus was needed in the first package.
on CNN's Fareed Zakaria stating that more needs to be done to shore
up the economy in the form of spending on public works and other
programs. On the flip side, Mr. Zakaria interviewed Harvard economic
historian Niall Ferguson who thinks we need to stop spending and
"radically simplify the tax code" to shore up business confidence. I embedded the video with both interviews below and will go over a few key points.
First, as I have
stated before, implementing austerity measures at a time when private
sector recovery is still fragile is very dangerous and will ultimately
threaten the global recovery.
Second, Krugman is right
that austerity will work against governments trying to shore up their
fiscal position. Why? Because if austerity slows the recovery, or worse
still, kills it, then governments will see their tax revenues shrink
dramatically. Imposing austerity measures during a fragile recovery is
akin to engaging in fiscal suicide.
Third, Krugman is right
about Ireland, Latvia and Estonia. They all implemented savage cuts,
unemployment went up, as did the cost of insuring their debt, and
government revenues dwindled. It has been nothing short of a monumental
Fourth, "invisible bond vigilantes" do not pose a
serious threat for the US or even Japanese bond market. Bond vigilantes
can easily pick on Greece, Portugal and maybe even Spain, but that game
has run its course too. The Europeans finally woke up and sent out a
strong signal to speculators in the form of a trillion
big, bad bond vigilantes are simply no match for the Federal Reserve and
they know it. Bernanke can squash them like a bug if they get too smug
and start speculating on US sovereign debt.
Fifth, as I wrote in
my last comment, the bond market is more
worried about a 1930s echo right now, which is driving yields
lower. If they were more worried of massive fiscal crisis leading to a
run on the US dollar, then yields would be skyrocketing up, not down.
I do not agree with all of Krugman's proposals. Spending on public
works is not a long-term solution to bolstering the labor market. You
need to implement a much more radical approach which will target new emerging
industries. I was happy to see president Obama announce that the
government is handing out nearly $2
billion for new solar plants, but this is a drop in the bucket,
Seventh, I think Mr. Ferguson is right that
we need to simplify the tax code, but I prefer a consumption tax which
does not penalize low income families over any flat income tax. Mr.
Ferguson was coy stating that "Keynesian policies were an abysmal
failure in the past". It wasn't Keynesian policies that led to the 1970s
stagflation episode, but supply shocks and funding the Vietnam war
through expansionary monetary policy.
Finally, one thing
Krugman said on ABC's This Week really struck me. He said he doesn't
like the term 'double-dip' because even of the US economy grows at 1%
but unemployment rises to 10.5%, it won't technically be another
recession, but that doesn't mean much to those who are currently
struggling to find work.
We are at a crossroad. Millions of
unemployed people are losing hope, waiting for policymakers to come up
with a program targeting job growth. Instead, all they are seeing is
political feuding that doesn't address the central core issue - jobs.
It's as if politicians have run out of ideas and go with whatever the
latest poll tells them is the flavor of the day. The lack of leadership
from politicians and business leaders during these unnerving times is
Let me end by wishing all my US readers a
Happy Fourth of July. As bad as it gets, never lose hope in America.