Guest Post: The Myth Of Austerity

Tyler Durden's picture

Authored by Philipp Bagus via the Ludwig von Mises Institute,

Many politicians and commentators such as Paul Krugman claim that Europe's problem is austerity, i.e., there is insufficient government spending. The common argument goes like this: Due to a reduction of government spending, there is insufficient demand in the economy leading to unemployment. The unemployment makes things even worse as aggregate demand falls even more, causing a fall in government revenues and an increase in government deficits. European governments pressured by Germany (which did not learn from the supposedly fateful policies of Chancellor Heinrich Brüning) then reduce government spending even further, lowering demand by laying off public employees and cutting back on government transfers. This reduces demand even more in a never ending downward spiral of misery. What can be done to break out of the spiral? The answer given by commentators is simply to end austerity, boost government spending and aggregate demand. Paul Krugman even argues in favor for a preparation against an alien invasion, which would induce government to spend more. So the story goes. But is it true?

First of all, is there really austerity in the eurozone? One would think that a person is austere when she saves, i.e., if she spends less than she earns. Well, there exists not one country in the eurozone that is austere. They all spend more than they receive in revenues.

In fact, government deficits are extremely high, at unsustainable levels, as can been seen in the following chart that portrays government deficits in percentage of GDP. Note that the figures for 2012 are what governments wish for.

Figure 1

The absolute figures of government deficits in billion euros are even more impressive.

Figure 2

A good picture of "austerity" is also to compare government expenditures and revenues (relation of public expenditures and revenues in percentage).

Figure 3

Imagine that a person you know spends 12 percent more in 2008 than her income, spends 31 percent more than her income the next year, spends 25 percent more than her income in 2010, and 26 percent more than her income in 2011. Would you regard this person as austere? And would you regard this behavior as sustainable? This is what the Spanish government has done. It shows itself incapable of changing this course. Perversely, this "austerity" is then made responsible for a shrinking Spanish economy and high unemployment.

Unfortunately, austerity is the necessary condition for recovery in Spain, the eurozone, and elsewhere. The reduction of government spending makes real resources available for the private sector that formerly had been absorbed by the state. Reducing government spending makes profitable new private investment projects and saves old ones from bankruptcy.

Take the following example. Tom wants to open a restaurant. He makes the following calculations. He estimates the restaurant's revenues at $10,000 per month. The expected costs are the following: $4,000 for rent; $1,000 for utilities; $2,000 for food; and $4,000 for wages. With expected revenues of $10,000 and costs of $11,000 Tom will not start his business.

Let's now assume that the government is more austere, i.e., it reduces government spending. Let's assume that the government closes a consumer-protection agency and sells the agency's building on the market. As a consequence, there is a tendency for housing prices and rents to fall. The same is true for wages. The laid-off bureaucrats search for new jobs, exerting downward pressure on wage rates. Further, the agency does not consume utilities anymore, leading toward a tendency of cheaper utilities. Tom may now rent space for his restaurant in the former agency for $3,000 as rents are coming down. His expected utility bill falls to $500, and hiring some of the former bureaucrats as dishwashers and waiters reduces his wage expenditures to $3,000. Now with expected revenue at $10,000 and costs at $8,500 the expected profits amounts to $1,500 and Tom can start his business.

As the government has reduced spending it can even reduce tax rates, which may increase Tom's after-tax profits. Thanks to austerity the government could also reduce its deficit. The money formerly used to finance the government deficit can now be lent to Tom for an initial investment to make the former agency's rooms suitable for a restaurant. Indeed, one of the main problems in countries such as Spain these days is that the real savings of the people are soaked up and channeled to the government via the banking system. Loans are practically unavailable for private companies, because banks use their funds to buy government bonds in order to finance the public deficit.

In the end, the question amounts to the following: Who shall determine what is produced and how? The government that uses resources for its own purposes (such as a "consumer-protection" agency, welfare programs, or wars), or entrepreneurs in a competitive process and as agents of consumers, trying to satisfy consumer wants with ever better and cheaper products (like Tom, who uses part of the resources formerly used in the government agency for his restaurant).

If you think the second option is better, austerity is the way to go. More austerity and less government spending mean fewer resources for the public sector (fewer "agencies") and more resources for the private sector, which uses them to satisfy consumer wants (more restaurants). Austerity is the solution to the problems in Europe and in the United States, as it fosters sustainable growth and reduces government deficits.

Lower GDP?

But does austerity not at least temporarily reduce GDP and lead to a downward spiral of economic activity?

Unfortunately, GDP is a quite misleading figure. GDP is defined as the market value of all final goods and services produced in a country in a given period.

There are two minor reasons why a lower GDP may not always be a bad sign.

The first reason relates to the treatment of government expenditures. Let us imagine a government bureaucrat who licenses businesses. When he denies a license for an investment project that never comes into being, how much wealth is destroyed? Is it the expected revenues of the project or its expected profits? What if the bureaucrat has unknowingly prevented an innovation that could save the economy billions of dollars per year? It is hard to say how much wealth destruction is caused by the bureaucrat. We could just arbitrarily take his salary of $50,000 per year and subtract it from private production. GDP would be lower.

Now hold your breath. In practice, the opposite is done. Government expenditures count positively in GDP. The wealth destroying activity of the bureaucrat raises GDP by $50,000. This implies that if the government licensing agency is closed and the bureaucrat is laid off, then the immediate effect of this austerity is a fall in GDP by $50,000. Yet, this fall in GDP is a good sign for private production and the satisfaction of consumer wants.

Second, if the structure of production is distorted after an artificial boom, the restructuring also entails a temporary fall in GDP. Indeed, one could only maintain GDP if production remained unchanged. If Spain or the United States had continued to use their boom structure of production, they would have continued to build the amount of housing they did in 2007. The restructuring requires a shrinking of the housing sector, i.e., a reduced use of factors of production in this sector. Factors of production must be transferred to those sectors where they are most urgently demanded by consumers. The restructuring is not instantaneous but organized by entrepreneurs in a competitive process that is burdensome and takes time. In this transition period, when jobs are destroyed in the overblown sectors, GDP tends to fall. This fall in GDP is just a sign that the necessary restructuring is underway. The alternative would be to produce the amount of housing of 2007. If GDP did not fall sharply, it would mean that the wealth-destroying boom was continuing as it did in the years 2005–2007.


Public austerity is a necessary condition for private flourishing and a rapid recovery. The problem of Europe (and the United States) is not too much but too little austerity — or its complete absence. A fall of GDP can be an indicator that the necessary and healthy restructuring of the economy is underway.

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Landotfree's picture

Both sides of this argument are wrong!

It does not matter if you cut government spending to zero or you continue on the spending spree.   The system is based on expansion at an exponental rate, once the system stops expanding at the given rate needed to sustain itself it's over.   The fat lady is not singing yet but she started warming up by the end of 2007 when the US system was still expanding at a rate of $4.7T a year.  

Philipp Bagus and Paul Krugman are completely idiots as they are trying to win an unwinnable war... the unwinnable war is the laws of the universe.   


sickofthepunx's picture

krugman is right.  i shudder to think where we would be today if there were no unemployment  checks, food stamps or insurance for the elderly after the financial collapse.


but i am sure plenty of the people on this board would have loved to find out just so their precious gold would be worth god knows what.

Landotfree's picture

Krugman is an idiot, he believes humans have unlimited power to sustain the equation.     Both sides really believe the same stupid thing, that humans can supply the equation limitlessly.   

I laugh at all these people, with their piles of paper, spreadsheets and forecasts.   Unless they can show me their unlimited power then it's just a matter of when, a matter of when can be roughly calculated by history.  

If the system were running smoothly it would be well north of $70T by now, but unfortunately or fortunately humans do not have unlimited power which is why the system is roughly still $53T.

GetZeeGold's picture



gold would be worth god knows what.


If he tells you....please let us know.

AnAnonymous's picture

Both sides really believe the same stupid thing, that humans can supply the equation limitlessly.

Both sides are 'americans'. Both sides are 'american' professional debaters. That means they avoid carefully anything that can put an end to their job/consumption, and here, anything that kills the 'american' debate they are thriving off.

Neither Krugman nor the 'american' austrian can address the reality of the world as it has been shaped by 'americanism'. Their only solution is to ignore it, work in duos as ideological partners who agree to avoid discussing any 'american' dimension and keep milking their respected supporters.

Today, after 'americans' having written off billions of human beings, it is 'americans' vs 'americans'

The 'american' side that manages to eliminate the other side will be the one picking up due to the re allocation of resources.

Landotfree's picture

Nice post, I tend to agree.   Humans must ignore it, if they do not ignore it, the system collapses instantly.   

Central Bankster's picture

You misunderstand. If krugman is right gold is overvalued and the economy will be on the mend from policies already in place.... Government deficits. If he is wrong then our gold is the only protection we have when his little monetary experiment fails.. Gold is insurance against idiotic central planning by people like krugman and his supporters like you. 

Landotfree's picture

When the system collapses, gold/silver/fuel/food/etc. on hand could be a good idea, however, gold in itself will do very little in saving the system.  IMHO   So, I tend to agree with you about possibly some of the benefits but a lot of gold bugs think that is the savior of the system.   Once the credit system goes, then liquidation will begin.   I would imagine a lot gold holders willl have to be liquidated with the rest, just like last time.

Having some gold on hand could help you personally avoid liquidation, but the unfunded liabilities will have to be liquidated and the process used is very random and non-specific.   Billions are going to have to go this time, that is my guess.

Central Bankster's picture

Thanks for your input. I must respectfully disagree. This whole site is designated to explaining why inflation is inevitable due to growing government debt. You must look at other modern government bankruptcies such as that of Argentina if you wish to properly prepare. Gold was exceptionally good insurance in all modern sovereign defaults that I am aware of, can you point to one that it failed? 

Central Bankster's picture

I would like to say though that of course in the short run gold might fall if some big players liquidate, but in the long run the exponentially rising monetary supply will push hard assets higher. 

Landotfree's picture

You say inflation is caused by government.  The problem being you are lacking the correct definitions and I, of course, disagree with plenty on this website because it's wrong Math.   The current $53T US credit system of the worldwide $200T credit system, only a fraction of that is has come from government spending, without that spending you would be going negative already... of course, the spending spree is just a temporary solution as the only real solution to the equation is collapse.

Inflation is the increase of money, in this case, the system of money is credit.   The system is barely expanding at all, let along exponentially to pay for the prior ie interest.   Gold can not address the problems of the system unless someone has unlimited power.   Now whether or not a gold piece will benefit you in the future as the system collapse I can not argue, it depends.   As far as gold helping save the system, well, that is just fiction, as the system is based on credit and the expansion of credit.  

Every system based on gold or silver whatever has collapsed in the past.   The Roman Empire was based on silver and eventually the output of the silver mines could not support expoenential growth of the system.  Rome collapse and went from a population of 1-2 million to less than 50,000 by estimates.   

I had this one idiot (I am not calling you an idiot), tell me he was going to buy up a whole walmart with items inside one day with one gold piece, I told him, you are going to go to walmart and the doors are going to be locked and there won't be any food on the shelves for him to buy.   He still didn't get.   This stuff does not exist because of money, it exists because you have a credit system which is sitting there like a ticking time bomb.

I am sorry but there is no backup system, this one collapses, then liquidation of the non-funded liabilities comes next... which is what everyone is running from.  

I tell you what, you have Congress cut government spending to zero today, by tomorrow the ATMs will stop working.   Of course, they will eventually stop working anyway but... it has nothing to do with government spending... the system is based on expoential growth... unless someone can supply it, it;s over.

A good example of this would be Japan, if Japan were truly a financial island, they would have collapsed decades ago, however since they are connected to the US and world to fund the equation for them... eventually Japan will collapse with the rest.   I would imagine Japan will be in this process for 50-70 years total, 1990-2040/2060.  A bunch of Japanese people are going to have to go, Asia has like 4 billion, no way you support that without a credit system.




Central Bankster's picture

I understand what you are trying to say.  I also disagree with your definition of money and inflation.  I suspect you are a MMTer.  But good luck with that, I will keep hoarding real goods.


I know that the system is screwed because too many are dependent upon the government credit- as you said and I generally accept your suppositions with respect to what was said to that in terms of what will happen to society if that spigot is turned off over night.

 I disagree with your assertions that gold and silver money failed throughout history, they did not.  What failed was the eventual dilution of the money systems.  In Rome both gold and silver were debased (the actual content of the coins was diluted) and as a consequence the coins (money) were hoarded and the velocity of the money collapsed under the debt of the government and financial system.  Not dissimilar to what is happening now.  Those who hoarded the original non diulted coins were relatively more successful than those who did not.  The issue here is fraud, and dilution and fractional reserve banking are a fraud.  I know that you disagree with this in principal.

R_J's picture

Krustman might believe Gold is overvalued, but hes not the only one.

I found this on GoldSeek and I have never heard this theory before:


"Paul van Eeden on Why Gold is Overvalued"


"TGR: The expectation that banks will eventually loan up to their lending capacity is what is causing the fears of hyperinflation and the gold price to go up.?"

"PvE: That is correct."

midtowng's picture

Deficits are a piss-poor way of deciding if austerity measures have been put into place.

If the economy is collapsing then of course the deficit is going to shoot through the roof because revenue will collapse too. That's just Econ 101. that the author can't figure that out is a poor reflection on him.

blunderdog's picture

The Mises guys are all idiots, but they've got a sizable audience of fantasists who are convinced that they're all going to become steenkin' rich when the dollar collapses and an ounce of gold becomes "worth" $50,000, or $500,000, or even ONE....BEEEEELYUN.....DOLLARS.

Gold's a great investment these days, but understanding that fact alone doesn't qualify anyone to lecture others about economics.  It seems obvious to me that the Mises folks are really only interested in hawking "publications" to dumbasses.

Bag Of Meat's picture

This text is just full of shit. Downvote, next article.

Plausible Deniability's picture

Krugman is right?????


Man do I wish that was true. Japan, entire euro zone, USSR, pre world war 2 Germany??? Somehow, we must begin to discuss economic and political matters in a Marxist way, meaning simply to analyze data with all ideology set aside. For instance, let's roll with Krugmans plan. Immediately, lets tak 1.4 (Krugman said at LEAST 2.3 trillion for stimulus) trillion onto our tab making our national debt 17.7 trillion. Using rounded numbers, that would put us at roughly 120 percent debt to gdp. Now, lets also assume that 90% (which I think is ridiculously low but we'll go with a best case scenario to illustrate the point) of that stimulus prescribed proved to be transient, leaving us with an additional budget expense of 150 billion. With tax revenues around 2.2 trillion, and government spending around 3.5 trillion (reflecting the additional 150 bill of retained expenses from the stimulus and additional 20 bill or so a year to service the additional debt acquired through the larger stimulus and larger deficits it would have created over the past 5 years), you would need tax revenues to grow by 60% just to balance the budget, and thats of course not counting the automatic spending increase of 3.5% a year or reflective of increasing numbers of baby boomers tapping into the entitlement programs. Presently, 5 years into the Obama recovery, we would need to grow GDP by an ADDITIONAL 24% (assuming we get tax revenues back to the sacred 18.5% of GDP).

To summarize, unless you care nothing about deficits, which Krugman admittedly doesn't, it's impossible to grow GDP quickly enough to ever catch back up to even with the national debt, let alone reach the 90% debt to GDP red line. What is occurring now is referred to im mathematics as an exponential divurgence between debt and GDP. You can't have it both ways. You either believe that debt matters or is immaterial. Krugman essentially believes its immaterial as we can print our own money. For now, he's right. But anyone with a base level of logic, a non-religious adherence to neo-keynesian economics and a crayon can run the numbers and realize there are only two outcomes possible. You forfeit your sovereignty in exchange for debt forgiveness (what Germany is being asked to do) or your money and economy becomes worthless, at which you point you also forfeit your sovereignty. There is simply no other long term outcome.

CH1's picture

I gave you a down arrow for calling Phiipp Bagus a total idiot, not for anything else.

There is no virtue in being a prick.

Landotfree's picture

Anyone that believes that humans can supply unlimited power to sustain the equation forever is an idiot.   

There really is no difference between the two idiots, just a matter of which small path you take at the end before the collapse happens, it's will collapse either way due to Math.   It was a ponzi scheme when it was started and it's still a ponzi scheme, no way to kind of blow up a ponzi scheme, it's either expanding or collapsing. 

Matt's picture

The universe is quite large and full of abundant energy. It could take many millions of years to use all that up, even with exponential growth.


Landotfree's picture

True, we are talking time.  Humans have have no ability to extract such energy at an expoential rate.

imapopulistnow's picture

Is it a ponzi scheme or perhaps a function of demographics.  Bottom line is that, as people age, they consume much less, drive less, need smaller housing, even eat less. (Statistics show they drink more and need more health care, but nearly every other category of consumption falls significantly.

Your premise is correct - that an economy based on growth gets clobbered once that growth rate permanently declines.  Just as with Japan, where aging became a factor 20 years ago, and now with Europe and the USA, each of our economies was geared towards the growing needs of young adults, new families, new households, etc.  Today that growth is not needed and that part of the economy greared towards continuous growth has collapsed and will not return.

Hence, we will follow poliicies similar to Japan and muddle through.  Hence also, there is little worry of "crowding out" private sector investment when the private sector has little need for whicih to invest. 

Peterus's picture

What do you define as system?

If government spending is 0 it also means no more legal tender debt-based money, no more fixed interest rates etc. Pretty much entire economy is turned upside down everywhere, also in what is now "private sphere" (but has to coexist with "public" one and defer to absolute power of authorities). What is this "system" if it is not set of rules upheld by violence and coercion and imposed by state powers on the World?

mayhem_korner's picture



The problem with the eurozone and the US is too much insanity.   Krugman et al must have special antibodies that destroy logic.

Tsunami Wave's picture

These people literally think they're a god.  Combine that with too much false confidence, like thinking coming from an ivy league school makes you smart, you teach your shit to 18-22 year old students that don't know better and 'totally agree' with you, you get recent-but-now prizes like the Nobel memorial prize, The MSM gives you de-facto protection from David Rockefeller's Council on Foreign Relations/Journ-o-List/Bilderberg group, you get a seat on the lifeboat when the collapse comes... and you've gone completely full retard.

AnAnonymous's picture

Krugman et al must have special antibodies that destroy logic.

Maybe. But useless.

All it takes is 'americans'.

'Americans' are those people who started by declaring unalienable rights to human beings like freedom, and kept slaves, or like property and organized the biggest land transfer ever recorded.

Being an 'american' is enough to explain their difficult relationship to even the most basic layer of logics.

Tsunami Wave's picture

"Maybe. But useless.

All it takes is 'americans'.

'Americans' are those people who started by declaring unalienable rights to human beings like freedom, and kept slaves, or like property and organized the biggest land transfer ever recorded.

Being an 'american' is enough to explain their difficult relationship to even the most basic layer of logics."



It sounds like you have special antibodies that constantly destroy logic in your brain.  Either that, or you shit it out constantly by the side of the road on your way to work where you troll everyone.

homonohumanus's picture

The issue is not the lack of logic, but the aversion to criticism.

AMericans are taught they are something special, they are close to racialists. They don't want to see their links ot the Old World" and how a lot of things that happened over there and are still happening are relevant to them.

Ultimately they want to decouple from History and live in a Story, I wonder if there is not a strong dislike of History, including in part their own. The only Historic thing the agree to relate to is Rome, then they won't agree on the fact that they are running an Empire.


Ultimately they saw us as inferior, that is why "the people" fail, they discard even constructive criticism or obvious lacking that may set their fate.


Not their fault, they are taugh that way. Love or Hate, black or white, with or against, no shade og grey for many of them.

I'm close to think that "American exceptionalism" has been bent inot something else, ie a tool of control for TPTB.

ajax's picture



I think this was posted before but it's good enough for a second go-round:

Confundido's picture

Rather than austerity, the problem is the distortion in relative prices...and everything is distorted: the price of capital (rates), capital structures (equity vs debt), capital factors (wages, land, tech...if you believe in this classification, anyway), imports vs local products, public education, name it....

homonohumanus's picture

How about the price of energy, it is the main reason why the prices of everything are out of wack.
Energy is still incredibly cheap if you adjust for inflation. We lived through a century during which energy was getting cheaper, the model is obviously unsustainable, all the surrounding ideologic, pseudo scientific, corpus is built on quick sand /loads of BS.

Cognitive Dissonance's picture

"Conclusion: Public austerity is a necessary condition for private flourishing and a rapid recovery."

1000 page tomes have been filled with all the reasons why we humans practice emotional, physical and psychological pain avoidance.

Public austerity may be a necessary condition for private flourishing and a rapid recovery. But it will only come about after all other approaches have been exhausted, including the public and private exhaustion of our denial regarding the painful journey ahead.

CH1's picture

And if we're very, very lucky, a few more humans will awake from the insane belief that has abused them since 5000 BC:

It is right for important people to order me around.

Opinionated Ass's picture

I love dad. He's strong. He disciplines me. He looks after me.

I love government. /sarc

ListLincolnBismarkRoosevelt's picture

People under King Henrie IV of France didn't had a painful journey, US after Roosevelt = THE technological superpower, aerospace and nulcear industry from France after plan Monnet,... Just saying hahaha !

Cognitive Dissonance's picture

We (the collective we) are well along with eating our seed corn. Peak denial is often reached just as we also reach peak self consumptive destruction.

<Bottoms up.>

ListLincolnBismarkRoosevelt's picture

New age stuff like denying the biggest consumer market of all time without public debt between 45 and 70' is not my type. I use also this historical improvement against communist. Are you ? Hahaha

Quinvarius's picture

The Fed has done nothing but enhance and project deflationary expectations as they inflate the shit out of the money supply to save the banking system.  All this austerity talk is more of the same.

venturen's picture

Uncle Ben says "Print baby print!!!"

Tsunami Wave's picture

The argument that I believe Austerity is necessary and good.... is just simply that these governments borrowed, printed, and spent too much money during typically good times, and now that everything is in the trough-end of the business cycle, you have the hangover effect of accumilating too much debt, so you have to slash public spending.  Period. 


So, in logical sense, the best thing to do is not postpone the business cycle as much as possible.  All of this painfully obvious shit can be avoided with.. hmm. What's it called? OH YEAH! A balanced budget.


The only sorta-way government spending would work during a recession is if the government has a large budget surplus.


People have to accept there will be pain.  We don't live in a perfect world.  These keynsian pussies, and indoctrinated citizens that expect money to be available in the EBT account every month have to learn this.  It's just how life works.

ListLincolnBismarkRoosevelt's picture

Wich business cycle ? The big picture is throwing our industrie away like the Indian Compagny + destroy the GlassSteagall after 60' years without finacial crisis. You are so cute. 

Tsunami Wave's picture

We're supposed to have a business cycle dammit!!!!!  None of this is cute... Even hookers have busy days and slow days! Agh.. just.. nevermind.   >: |

ListLincolnBismarkRoosevelt's picture

Hooker didn't progress in science while war and underdeveloppement of the world...  The City as financial offshore center and UK-US militar comba forbid any thruth study on the matter.  

Stuck on Zero's picture

Q: If the government spends more money what do you get?

A: More government.


buzzsaw99's picture

what a bunch of crap

ugmug's picture


Keynesian Economics – An Economic Fairy Tale

While there are many idiotic political theories bouncing around DC like unmanned bumper cars the most idiotic is the theory of Keynesian economics. Keynesian economics is the belief that making government bigger will subsequently make the overall economy grow bigger. 

If Keynesian economics were true then placing fish in a bigger body of water will automatically make the fish grow bigger.

If Keynesian economics were true then placing a blade of grass in the same soil as a tree will automatically make the grass grow as big as the tree.

If Keynesian economics were true then making our atmosphere bigger will automatically cause all living things that breath the air grow bigger.

If Keynesian economics were true then making one variable common to all others bigger (air, soil, water, government spending, etc,) will cause all other dependent variables (animals, plants, mankind, taxpayers) grow bigger in unison.

Keynesian economics is the most absurd theory ever devised by rational man. It is an economic fairy tale.


AnAnonymous's picture

Keynesian Economics – An Economic Fairy Tale


'American' economics, an economic fairy tale.

Been the main drive on the state of the world since 1776, July, 4th.

ListLincolnBismarkRoosevelt's picture

Roosevelt was aigainst Keynes and the British. It is so british to speak only of Keynes. Are you british ?

odatruf's picture

There is so much wrong with this tripe that I can't even begin to unwind it.  And I am frightened by those who can't see it.