By Michael Baxter
Look, you have to be patient. It takes time to repay debt, but once it is repaid, well…yippee. That is one argument.
Others go further, and say things such as: “If it isn’t hurting, it isn’t working.”
Those who support austerity don’t deny it will be painful — except that is for a few nutters in the US Tea Party that seem to think there is an automatic and immediate positive relationship between austerity and growth. No, the sane austerians are simply saying that it is worth it in the long run: pain today, wealth tomorrow.
And, of course, for most individuals such an attitude is right. Some businesses may argue that the way to deal with debt is to expand, but on the whole, most agree that times of peril mean cuts.
The snag is that when we are talking about the whole economy, things can get very nasty if we all start behaving in the same way. If all those with debts make cutbacks, and as a result there is less demand, and those with savings see the fall in demand, so start saving even more, then the economy will start contracting faster. And supposing that as a result of these cuts, demand shrinks, our income falls, and as a result our debts actually increase. In such circumstances, the more we cut back, the worse our debts.
The National Institute of Economic and Social Research (NIESR) reckons this is precisely what’s happening.
In a report published this morning it said: “As a result of the fiscal consolidation plans currently in train, debt ratios will be higher in 2013 in the EU as a whole rather than lower.”
Its argument continued: “under normal circumstances a tightening in fiscal policy would also lead to a relaxation in monetary policy. However, with interest rates already at exceptionally low levels, this is unlikely or unfeasible.” To put it another way, when interest rates are near zero, the argument that you need to make cuts so that the central bank can then make interest rate cuts doesn’t hold up. Right now, we are in what’s called a liquidity trap. Rates can’t fall much further, but when the economy is struggling like it is, the normal solution is to cut interest rates. Quantitative easing is not proving very effective because people don’t want to borrow more.
The Bank of England hopes, by the way, that QE will push up the price of government bonds, meaning other assets will look cheap in comparison and push their prices up, which will make us feel richer, so that we will spend more.
Returning to the NIESR report it stated: “During a downturn, when unemployment is high and job security low, a greater percentage of households and firms are likely to find themselves liquidity constrained.”
NIESR added — and this is the key bit — “With all countries consolidating simultaneously, output in each country is reduced not just by fiscal consolidation domestically, but by that in other countries, because of trade. In the EU, such spill-over effects are likely to be large.”
Now it is only right to point out at this stage that the NIESR director, Jonathon Portes, is very much a supporter of the idea of stimulus. He bats for the same side as Paul Krugman — an out an out supporter of Keynesianism. So given this, perhaps the conclusions of the NIESR report are not surprising.
But then again austerity can work when applied by individual countries which can simultaneously grow via exports. But when austerity becomes a global thing, it becomes very dangerous.
On the other hand...
The big snag with fiscal stimulus is that sometimes economies need to adjust. There is a danger that a fiscal stimulus can take away the need for change.
Take Japan, as an example. In Japan failure is not popular. In fact, it is seen as something that needs to be avoided at all costs. But as a result, maybe Japan is too slow to change. This morning both Sharp and Panasonic warned of heavy losses in their current financial year. Truth is, Japanese electronics companies are getting a drubbing. Being thrashed by Apple, and Samsung and Google and Amazon is bad enough, but now even Microsoft with its Surface tablet is making the once seemingly invincible Japanese giants look like dinosaurs.
Maybe Keynesian is partly to blame. There’s not enough creative destruction in Japan.
So returning to the NIESR, it is right. Austerity is causing damage, and may even be making debt worse, but that does not mean we don’t need creative destruction.
The debate has become polarised. Either you are an Austerian or a Keynesian. Why can’t you be both?
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