Thanks a lot, austerity! We could have had 2014's economic recovery in 2011.
How we could have had 2014's economic recovery in 2011
Last year boasted the strongest job numbers since 1999, and as a result, many commentators have concluded that left-wing critics of austerity were wrong all along. The basic case — advanced by Jeff Sachs, Scott Sumner, and others — is that the surge in growth and jobs proves that austerity is not the poison its detractors claimed it would be.
These commentators make some good points. But they are wrong about austerity. A close examination of the counterfactuals shows that austerity almost certainly held back the recovery — and without it, we might have had 2014's strong numbers in 2011.
So what is their argument? Sachs is, as usual, a weird muddle of left- and right-wing ideas. He contrasts Paul Krugman's celebration of good economic news in 2014 with dire predictions Krugman made in 2013, particularly in this column, which speculated a full recovery may never happen.
The rebuttal here is easy: Krugman did not say a recovery had been fully achieved, but that the numbers in 2014 were pretty good, especially by recent standards. Unemployment has definitely not reached bottom yet, GDP is still at least 3 percent below trend, and hysteresis is still a screamingly bad problem.
The monetarists, like Sumner, are more coherent. They argue that austerity can't hurt the economy because of the "monetary offset." This refers to the idea that monetary stimulus, in the form of interest rate cuts or quantitative easing by the Federal Reserve, will counteract any downward pressure on aggregate demand produced by fiscal austerity (i.e., tax increases and/or spending cuts). Conversely, in this view high-spending fiscal policy won't boost the economy, since any increase in demand will be tamped down by the central bank.
Sumner argues that some liberals predicted a recession in 2013 due to austerity, and since there wasn't one, the monetary offset must be responsible. Straight away this argument runs into a problem. The supposedly omnipotent central bank did not actually change anything in 2013 to offset austerity, except to repeatedly state that "fiscal policy is restraining economic growth." Since a major way monetary stimulus is supposed to work is through influencing expectations, that's a major blow against the monetarist case.
But it doesn't make the anti-austerity case by itself. A few such people probably did predict recession, but the strong version of this thesis is that austerity cut jobs and growth relative to what they would have been otherwise, not that it forecloses any recovery forever. (Arguing counterfactuals is always slippery, but until we can rewind time, it's impossible to avoid.)
The history here is tangled, with three separate rounds of QE, each different from the last; various confounding factors from around the globe, like the near-collapse of the Eurozone in 2012 and subsequent depression; and varying sizes of austerity packages. Mike Konczal does yeoman's work keeping the story straight here.urozone in 2012 and a subsequent depression; and varying sizes of austerity packages. Mike Konczal does yeoman's work keeping the story straight there.
However, it's not necessary to get hip-deep in the details to see the basics of the anti-austerity case. Here's a chart of government spending, a reasonable stand-in for austerity:
This shows the rate of change, so values below zero represent decreasing spending and vice versa. We see the big stimulus in 2009, the turn to austerity in 2010-11, and the smaller round of cuts in 2013. Only in mid-2014 do we get back to positive territory — and hey presto! At just that time both the job market and GDP posted the best numbers in years.
It's not a dispositive case, of course. As any honest economist will tell you, econometrics is squishy enough to produce any result you want. But the fact that the economy sprung (weakly) back to life at the very moment the austerity screws were loosened, combined with strong theoretical support, is compelling. And when you look at nations in general, there is clear relationship between austerity and recession — or conversely, between stimulus and growth. Which is all a long way of saying Keynes was right.
What that suggests, in turn, is that we could have had 2014's economic recovery in 2011 or even 2010, if the stimulus had been the proper size. The grim economic damage of the last six years — representing millions of lives crushed — was completely avoidable.