The Wrong Medicine: Why fiscal austerity is a bad idea for a slumping economy

[marmar]

from Dollars & Sense:



The Wrong Medicine
Why fiscal austerity is a bad idea for a slumping economy.

By Alejandro Reuss


As protesters take to the streets in Europe to oppose government spending cuts, proponents of austerity in the United States and Europe claim that immediate moves to reduce government deficits are the way to renewed economic growth. Accepting a little pain now, they argue, will reduce the pain in the long run.

Those familiar with Keynesian economic theory will find the austerity-to-growth claims surprising. Fiscal austerity, or a “contractionary fiscal policy,” means either spending cuts or tax increases, or a combination of the two. Reductions in government spending reduce total demand directly. Government spending on real goods and services is just as much a part of total demand as private consumption or investment spending. Spending cuts can also reduce demand indirectly, as those who would have received income as a result of government spending cut back on their spending as well. Tax increases reduce demand by reducing the disposable incomes of private individuals, who then spend less. Either way, lower demand for goods and services can translate into less output and employment.

How, then, is fiscal contraction supposed to lead to growth? Austerity proponents argue that balancing government budgets and reducing public debt will boost private-sector “confidence.” As public debt increases, the argument goes, people may become wary about spending, since they will be on the hook (through taxes) to pay down that debt in the future. Individuals and firms will spend more freely now if they do not have future taxes hanging over their heads.

The pro-austerity faction has relied heavily on a few recent studies, especially one by Harvard economists Alberto Alesina and Silvia Ardagna claiming to have identified 26 cases in which fiscal contraction led to renewed growth. This conclusion, however, has not stood up to careful scrutiny. Economists Arjun Jayadev and Mike Konczal, after studying the cases that Alesina and Ardagna describe, find that “in virtually none did the country a) reduce the deficit when the economy was in a slump and b) increase growth rates while reducing the debt-to-GDP ratio.” ..............(more)

The complete piece is at: http://www.dollarsandsense.org/archives/2011/0711reuss.html

[indepat]

1. What RW view of what the economy really needs is much more austerity and further tax cuts

for large corporations, a corporate tax holiday, and more tax cuts for the uber-wealthy. :patriot:

[Patiod]

2. Well, isn't that what the MSM has been pushing?

Seriously - coverage has been almost completely one-sided: why we need to treat our economy like a family budget (a family that doesn't pay its bills); why we have to cut,cut,cut without raising taxes on "job creators"; why we need to stop "mortgaging the future".

NOW we're hearing from people like economist Greg Ip about the potential damage of withdrawing any hope of government stimulus.

If Republicans are the clear winner from this deal, the economy is the loser. An ideal deficit-reduction package would have coupled near-term stimulus with long-term consolidation that stabilised then reduced the debt as a share of GDP. This deal certainly doesn’t do the first and it’s unclear that it will do the second. True, it does not add significant new fiscal tightening: total discretionary spending would be a mere $7 billion lower in fiscal 2012 and $3 billion in fiscal 2013 than current levels, according to a Democratic Senate fact sheet. On the other hand fiscal policy is already set to tighten automatically. Mr Obama had hoped to extend the payroll tax cut as part of the deal. He may yet do so during the Congressional negotiations, but that seems a fading prospect. It is striking that last Friday’s appallingly weak GDP data did nothing to shape the deal any further in the direction of near-term stimulus.