It’s really amazing to see how quickly the notion that contractionary fiscal policy is actually expansionary is spreading. As I noted yesterday, the Panglossian view has now become official doctrine at the ECB.
So what does this view rest on? Partly on vague ideas about credibility and confidence; but largely on the supposed lessons of experience, of countries that saw economic expansion after major austerity programs.
Yet if you look at these cases, every one turns out to involve key elements that make it useless as a precedent for our current situation.
Here’s a list of fiscal turnarounds, which are supposed to serve as role models. What can we say about them?
Canada 1994-1998: Fiscal contraction took place as a strong recovery was already underway, as exports were booming, and as the Bank of Canada was cutting interest rates. As Stephen Gordon explains, all of this means that the experience offers few lessons for policy when the whole world is depressed and interest rates are already as low as they can go.
Denmark 1982-86: Yes, private spending rose — mainly thanks to a 10-percentage-point drop in long-term interest rates, hard to manage when rates in major economies are currently 2-3 percent.
Finland 1992-2000: Yes, you can have sharp fiscal contraction with an expanding economy if you also see a swing toward current account surplus of more than 12 percent of GDP. So if everyone in the world can move into massive trade surplus, we’ll all be fine.
Ireland, 1987-89: Been there, done that. Let’s all devalue! Also, an interest rate story something like Denmark’s.
Sweden, 1992-2000: Again, a large swing toward trade surplus.
So every one of these stories says that you can have fiscal contraction without depressing the economy IF the depressing effects are offset by huge moves into trade surplus and/or sharp declines in interest rates. Since the world as a whole can’t move into surplus, and since major economies already have very low interest rates, none of this is relevant to our current situation.
Yet these cases are being cited as reasons not to worry as austerity becomes the rule.
You know what? I’m worried.
Friday, June 18, 2010
From Paul Krugman's blog. Many of the references are links in the original.