“Expansionary austerity,” in bad times and good

Enthusiasm for budget-balancing swept Europe in 2010 in the wake of the financial crisis, just as the Tea Party movement was taking root in the United States.  (See this four-minute history of the American events to refresh your memory.) The difference is that, in Europe, “expansionary austerity” was taking hold at the highest levels of government. In the United States, it did not.

In April of that year, Harvard University professor Alberto Alesina told European Union finance ministers in Madrid that “large, credible, and decisive spending cuts” often had been followed by growth since 1980, working their magic mainly by altering expectations. In May, 43-year-old David Cameron, campaigning on an austerity platform, became the first coalition prime minister in Great Britain since World War II – and the youngest PM in almost 200 years. In June, G-20 presidents and prime ministers meeting in Toronto promised to halve their budget deficits by 2013. In Bloomberg BusinessWeek, economics editor Peter Coy wrote that it was “Alesina’s hour.”

The US midterm elections followed in November. Six Democratic senators and sixty-three representatives were defeated, many of them by Tea Party candidates.  But President Barack Obama dug in.  There followed a long summer in 2011 during which Republicans repeatedly threatened to default on Treasury debt if their demands for budget cuts weren’t met. Obama subsequently won a handy re-election victory in 2012. He then embraced making permanent the provisional Bush tax cuts of ten years before (excepting those on the highest earners), in the name of providing additional necessary stimulus to the still-struggling economy

Now the funny thing is that the most successful episode of “expansionary austerity” to be found anywhere in recent history occurred in the United States, in the early 1990s, in the years after Bill Clinton defeated George H.W. Bush.  Conventional wisdom among pundits friendly to the Democrats was that considerable stimulus spending was needed to revive an economy laid low by interest rate hikes tax increases after the first US war in the Persian Gulf.

But Federal Reserve chairman Alan Greenspan, at lunch with the newly elected Clinton, advocated a highly public measure of belt-tightening instead. “Credible action to reduce the federal deficit would force long-term interest rates to drop as markets slowly moved away from the expectation of inevitable inflation,” he told the president-elect, according to Bob Woodward in Maestro: Greenspan’s Fed and the American Boom, spurring a round of mortgage borrowing and consumer spending.  Deficit reduction would boost employment instead of adding to the jobless rolls. Clinton’s economic team urged much the same; the president took the risky step: and things worked out more or less exactly as expected.

But all kinds of differences existed between the US economy in the early ’90s and European and US economies in 2010, beginning with the fact that in ’10 both were still suffering from the worst contraction since the 1930s, whereas in 1993 they were on the verge of an tidal wave of high-tech investment and productivity growth, not to mention the appreciation of the dollar 1995-2002 and low oil prices, at least until 1999. One thing that wasn’t different was that in 2010 US policy-making was once again partly in the hands of the man who had helped execute the policy in 1993.  Then it was Deputy Assistant Treasury Secretary Lawrence Summers who elicited the views from Wall Street bond traders that permitted his bosses, Treasury Secretary Lloyd Bentsen and National Economic Council director Robert Rubin, to design the package of budget cuts that touched off a virtuous circle that lasted for most of a decade. In 2009 it was again Summers who, as director of the NEC, made the case for stimulus that kept the US from slipping deeper into recession.

The US succeeded in staving off the budget cutters and so seems to have entered the early stages of an expansion. But Europe took the bait, and is now stumbling along.  (See this assessment by Anis Chowdhury, of the University of Western Sydney, Australia, part of a VoxEU Debate last year, for an illuminating examination of the European experiment.)  The seventeen countries of the Eurozone that share a common currency have one set of well-publicized problems:  the Euro is in danger of coming apart.  Now the UK may hold a referendum in the next year or two on the possibility of pulling out of the 27-member European Community altogether.

One moral of the story is that it matters which Harvard economist you take your guidance from. Carmen Reinhart, of Harvard’s Kennedy School of Government, and Kenneth Rogoff, of its Economics Department, also entered the austerity debate in early 2010, when they ventured that there may be a limit of around 90 percent in the ratio of public debt to GDP after which the likelihood of financial crisis increases.  Tea Party deficits hawks, including Rep Paul Ryan (R-Wis.) quickly took the warning to heart.  But there’s a world of difference between warning that such vulnerabilities exist and counseling quick action in hopes they will diminish.  “Expansionary austerity” is real enough.  As is so often the case, it’s a matter of timing and degree.

5 responses to ““Expansionary austerity,” in bad times and good”

  1. Nice piece, as always, but I’d say that you may have overstated the importance of fiscal policy, stimulus and austerity both. Maybe the importance of Harvard economists, too, but that’s another story.

  2. Isn’t Canada in the early nineties an even better example of a country that sucessfully brought off painfull austerity. It benefited from the boom in the US and managed to raise its credit rating. The process was still painfull.

  3. “The US succeeded in staving off the budget cutters and so seems to have entered the early stages of an expansion. But Europe took the bait, and is now stumbling along.”

    Looking at this strictly in terms of the data I’m not sure this is the case.

    For example if one looks at the April 2013 IMF Fiscal Monitor the cyclically adjusted general government primary deficit started to decline in the US, the eurozone, and the UK in 2011, 2011 and 2010 respectively.

    Similarly if one looks at total general government spending as a percent of potential GDP, it peaked in the US, the eurozone, and the UK, in 2010Q2, 2010Q3, and 2008Q3 respectively. Thus it appears that the UK led the other two currency areas in implementing fiscal consolidation, but the US and the eurozone started more or less simultaneously.

    The chief policy difference between the US and the eurozone appears to be monetary policy. The monetary base has increased by nearly 250% since August 2008 in the US but is up by less than 50% in the eurozone. This is in large part due to the fact that the Fed has now done three rounds of QE but the ECB has yet to do even one.

  4. […] Principals – David Warsh: ‘”Expansionary austerity,” in bad times and good’ “A blog post which acknowledges the existence of “expansionary austerity”. It briefly […]

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