Back in 2009, when there was (briefly) a policy consensus in favor of active fiscal policy to fight the economic slump, there were many warnings to the effect that we must not repeat the infamous mistake of 1937, in which President Franklin D. Roosevelt was persuaded to focus on balancing the budget while the economy was still weak, terminating the recovery and sending the United States into the second leg of the Great Depression.
And what policy makers proceeded to do was, of course, to repeat the mistake of 1937.
The International Monetary Fund’s new World Economic Outlook is, in effect, an extensively documented exercise in hand-wringing over the consequences of this repeat of bad history. Kudos to the Fund for having the courage to say this, which means bucking some powerful players, as well as admitting that its own analysis was flawed.
There is, however, one point that I think is getting skewed in the discussion of the I.M.F.’s new concern over premature austerity. Much of the discussion seems to focus on the question of whether to relax demands on debtor countries — which is certainly a crucial issue for the euro zone. However, the global 1937 that we’re now experiencing isn’t just about forced austerity in Spain, Greece and other nations. It’s also — and I think mainly — about unforced austerity in countries that remain able to borrow very cheaply.
Look at estimates of cyclically adjusted budget deficits the I.M.F.’s Fiscal Monitor, measured as a percentage of potential gross domestic product, on the chart on this page. I don’t think you want to take these numbers as gospel — in Britain’s case, at least, there’s a very good argument that the I.M.F. is greatly understating potential output and, hence, overstating the structural deficit, and I suspect that this is true to a lesser extent for the United States.
But the point is that even cheap-money countries facing no pressure either the market or external forces to engage in immediate austerity are nonetheless engaged in sharp fiscal contraction.
This is taking place in an environment in which the private sector is still deleveraging ferociously the debt binge of the previous decade, so we’re creating a situation in which both the private sector and the public sector are trying to slash spending relative to income. And, whaddya know, the world economy is sputtering.
The truly amazing thing is that this calamitous error is not, for the most part, the result of special interests or an unwillingness to make hard choices. On the contrary, it’s being driven by Very Serious People who pride themselves on their willingness to make hard choices (which, naturally, involve inflicting pain on other people). In fact, I’d argue that the desire to make hard choices, or at least to be seen as doing so, is the reason these Very Serious People chose to ignore the extensive and, we now know, completely accurate warnings some economists about what would happen if they gave in to their austerity obsession.
Izabella Kaminska at the Financial Times’s Alphaville blog recently wrote that I was feeling a bit “smuggish” about all this. Well, I’m only human. But, truly, this is a terrible thing to behold.
Changing course
Following a meeting of the International Monetary Fund in Tokyo in October, officials indicated in a statement that they had underestimated the negative impact of austerity on growth.
Throughout its history, the I.M.F. has been criticized for imposing harsh terms of austerity on nations in crisis as a condition of their receiving billions in aid. The fund required governments to sharply cut spending, raise taxes and tighten monetary policy — a set series of moves that was later seen to have dampened economic growth in most cases. Many economists argued that the decline in output would cancel out any deficit reduction harsh austerity, and inflict needless pain on the working class in struggling nations.
Now the organization is urging countries with high levels of debt to ease austerity measures and implement stimulus efforts instead.
According to I.M.F. officials, the heavily indebted GIPSI nations (Germany, Ireland, Portugal, Spain and Italy) should be givenmore time to reduce their budget deficits, and wealthier nations should prioritize growth over consolidation in order to increase global demand.
“We need to act decisively to break negative feedback loops and restore the global economy to a path of strong, sustainable and balanced growth,” they said in a joint statement at the end of the three-day meeting. “Fiscal policy should be appropriately calibrated to be as growth-friendly as possible.”
The I.M.F.’s recently released World Economic Outlook report supports this sentiment.
The researchers analyzed 26 historical episodes where the debt of developed countries reached 100 percent of gross domestic product and concluded that public debt can only be reduced slowly, through a combination of growth and structural reform.
The report suggests that amid a sluggish global economy, the implementation of harsh austerity measures will not effectively reduce budget deficits, and may actually increase them.
Professional Success, at Odds With the Past
I’ve been thinking in odd moments about my professional state of my mind, and thought I’d share a bit. (I know, too much information.)
A starting point: It is a truth not universally acknowledged that it’s possible to be a highly successful academic and still have a somewhat fragile sense of self-worth. You get your papers published, you get tenure, maybe you win some prizes; all this says that your colleagues believe that your stuff is right, that you really do know something about your subject. But do you really? Or are you just good at self-marketing?
Some — maybe many — academics don’t care; they’ve carved out a nice career and life, so it’s all good. But if you are truly serious about your work as opposed to your career, the question of whether your knowledge is real is always with you.
As you’ve already guessed, I’m talking to some extent about myself. I’ve always been very serious about my work, and I’ve always tried to be more than a mere careerist. I’ve had a wonderful career, getting all the major gongs, yet as late as 2008 it was still possible for that small self-doubting voice in my head to whisper that being a facile modeler and a pretty good writer might not mean that I really knew how the world works.
And then the crisis came — a crisis that was very much up my alley. I got obsessed with Japan in the 1990s, and I think I can fairly claim to have started the whole modern liquidity-trap literature. I approached the Japan problem the way I approach just about all economic problems, by building a stylized, minimalist model that seemed to make sense of the available facts and yielded strong conclusions.
But does this style of analysis work in the real world?
Well, events provided an acid test. Those who believed in the little models I and others were using made some very striking predictions about how the world would work post-crisis. These predictions were very much at odds with what other people were saying: that trillion-dollar deficits would not drive up interest rates; that tripling the monetary base would not be inflationary; that cuts in government spending, rather than helping the economy by increasing confidence, would hurt by depressing demand, with bigger effects than in normal, non-liquidity-trap times.
And the people on the other side of these issues weren’t just academics; they were major-league policy makers and famous investors.
And guess what: the models seem to work. It appears that I wasn’t just a successful self-marketer, that I really did and do know something.
So that’s great — except that it turns out that one form of anxiety has just been replaced with another. It’s great to have confirmation that you weren’t just playing career games; it is, however, not just frustrating but terrifying to watch decision-makers ignore all the hard-won evidence and knowledge, and repeat the mistakes of the 1930s.
