Replies to post #100059 on Tornado Alley (PROG)

[StephanieVanbryce]

The Wrong Message on Deficits

June 9, 2010

The whip-deficits-now fever is running hot on both sides of the Atlantic. In Europe, politicians are understandably spooked by investors dumping government bonds in the wake of the Greek meltdown. But the sudden fierce enthusiasm for fiscal austerity, especially among stronger economies, is likely to backfire, condemning Europe to years of stagnation or worse.

The United States is running the same very high risk. Democrats have soured on job creation and economic stimulus in favor of antideficit rhetoric, which Republicans have long seen as the easy road to discontented voters in a confusing election year.

At a hearing on Wednesday, the Federal Reserve chairman, Ben Bernanke, said job creation and financial-stabilization programs were essential to stop recession from becoming depression, but he also called for “a strong commitment to fiscal responsibility in the longer run.” The emphasis in that statement should be on that “longer run,” but we fear many politicians weren’t listening for nuance.

The economic crisis isn’t over. Nearly 1 in 10 workers is still unemployed in the United States and in the European Union. Germany, Europe’s most robust economy, suffers 7 percent unemployment. In Spain, it is nearly 20 percent. Still, the German government plans to cut its budget deficit from 5 percent to 3 percent of gross domestic product by 2013. The Spanish government promised to cut to 6 percent from 11.2 percent. The new British government promised to take an ax to spending when it proposes its budget on June 22.

The enthusiasm for budget cutting has spread beyond the United States and Europe. A meeting last week in South Korea of finance ministers from the Group of 20 large economies applauded deficit-reduction talk.

The Obama administration has warned that the new austerity drive could undercut economic recovery and has pressed the case that stronger countries, such as Germany, should not slam on the brakes. In a letter to G-20 colleagues, Treasury Secretary Timothy Geithner warned that budget cutting won’t work “unless we are able to strengthen confidence in the global recovery.”

Weak European governments cannot ignore investors dumping their bonds, and they will eventually have to curb their gaping budget deficits. But for everybody to slash public spending when growth is faltering and unemployment remains stubbornly high risks undercutting the goal of fiscal probity by slowing economic growth and reducing tax revenues.

The global recovery is already faltering. China’s economy is losing momentum. The United States’ is slowing. If budget cutting depressed economic growth, the reaction from investors would be no less brutal than their current attack on European bonds.

The problem calls for a varied response. Some countries, such as Spain or Portugal, may have to drastically cut their budgets if they don’t want to lose their access to capital markets. But countries such as Germany, Britain and the United States have space to spend.

Interest rates on German and U.S. bonds remain low. Rates on British debt also are very low, reflecting better growth prospects than those of the countries that use the euro. For them, the best policy should be to take advantage of the cheap money to spend more, not less.

Deficits will have to be reduced once the recovery gains more traction and unemployment recedes. Right now, for the most robust economies — the United States, Germany, Britain, Japan — slashing budgets is the wrong thing to do.

http://www.nytimes.com/2010/06/10/opinion/10thu1.html?hp

[StephanieVanbryce]

Myths of Austerity

Published: July 1, 2010

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 deeply depressed.

This 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.

Bond 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.

But 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 recovery.”

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.

Paul Krugman
http://www.nytimes.com/2010/07/02/opinion/02krugman.html?ref=opinion