In 2008, the Keynesians emerged from hiding, where they had been since the mid-1980s. It was nice to see them, catch up, and so on. But now they won’t go away.
This week’s Buttonwood column in The Economist considers whether fiscal austerity is expansionary or contractionary. A sentence caught my eye.
Keynesian economists are also likely to counter the Canadian example [in which fiscal austerity was followed by prosperity] with that of Ireland today, where a willingness to appease the bond markets with budget cuts has been accompanied by a fall in nominal GDP of almost a fifth.
Last week in the New York Times, Christy Romer’s debut column claimed:
Ireland, Greece and Spain have all had rising unemployment after moving to cut deficits.
OK, I can agree that Ireland, Greece, and Spain all cut their deficits, and that they all had rising unemployment. I will leave aside, for this post, the question of what their unemployment rate would have been if they had not appeased the bond market, because in the US context it is irrelevant. The US is not yet on the immediate verge of a sovereign debt crisis.
What is important in the US context? Ireland, Greece, and Spain differ from the US in a way that is so inescapably essential in theory that it makes me want to revoke the credentials of any economist who cites them as evidence. Yes, dear reader, you guessed it, none of them runs its own monetary policy.
The monetary authority moves last. It incorporates the actions of the fiscal authority into its choices. If the fiscal authority decides to be austere, the monetary authority can be loose. The friendly Keynesians who cite the experiences of countries without their own currencies as evidence of the evil of austerity during a recession are trying to trick you.
If anything, Eli, those three economies provide an excellent controlled experiment to examine the effects of spending cuts without easy money. No one is trying to trick you. I can tell from Europe, quite simply, that most people are scared as hell. The Irish don’t control a central bank that can flood the economy with euros, and they have decided to hack 15 billion euros worth of demand out of the economy over the next four years. They are already paying the price in unemployment, net emigration and rising petty crime. The government is the most unpopular ever, and when the next election is held, it will probably fall. But barring a radical new policy, its successor in office will face the same constraints, as the country slips toward social unrest.
Demand needs to come from somewhere for an economy to grow. When consumers are scared of deflation, and business is scared of downturns, that demand has to come from government. That’s all the Keynesians are saying, and the point is irrefutable. It’s an accounting identity. If you remove the spending, the economy shrinks. For Canada in the 1990s, the spending came from America and the rest of the world. But Ireland can’t count on that, since foreign trade isn’t enough to compensate for its domestic situation.
I’m all for cost-effective government, but now is not the time for cuts.
I think we disagree on what a “controlled experiment” is. To my mind, a controlled experiment would require a country in a similar situation to Ireland, Greece, or Spain to remain profligate. As I implied in the post, I think that if these countries ignored bond markets and kept spending, unemployment would be much higher than it is now.