Keynes' Revenge: What's making Euro austerity cuts fail so badly?

Great Debates
41

Everyone seems to be glossing over an important point, and perhaps subconsciously conflating Ireland with Greece.

Greece’s problems arose because they’re one of those classic European socialist nightmares, with lots of government spending to prop up employment and entitlements in a place that really only has tourism to offer to the rest of the world, coupled with widespread tax evasion. They were pretty much destined to become a mess.

Ireland had nowhere near the levels of government debt that Greece had before this crisis. All their problems arose because they made the decision to bailout their financial sector, which includes the subsidiaries of foreign banks who set up shop there to take advantage of Ireland’s lax regulation and low corporate taxes. In fact, foreign bank claims on Ireland are 3X that of Greece (see here; Simon Johnson also estimates that 20% of Irish GDP is from “ghost corporations” that engage in little to no real economic activity in Ireland, they’re simply there for purposes of tax and regulatory arbitrage).

So German banks create subsidiaries in Ireland, where their banksters will be allowed to gamble on the housing bubble in ways they weren’t permitted to at home. After the bubble bursts the banksters lean on their cronies in government, who in turn lean on Ireland to backstop their losses. Once that decision is made, Ireland loses all flexibility in responding to the economic downturn. In order to please the bond markets they slash domestic spending, the only real avenue they have left to try and tackle this new debt, which results in economic contraction. Because the economic outlook unsurprisingly looks bleak, Ireland’s borrowing costs end up rising anyway.

As to the OP: well, it’s simply economics. If business and consumer spending plummets, then government spending has to pick up the slack. I don’t consider that to be a controversial proposition. The debate occurs when you have to decide if the government can afford to incur debt to fuel its spending or whether it can spend in ways that aren’t wasteful.

42

Moidalize, can you answer a question for me? You’re saying the Irish didn’t temporarily nationalize their banks and restructure them. Instead, they just guaranteed the debt in full? Is that correct? Because I don’t understand why a government would choose to guarantee the debts in full.

43

Backstopping the banks can be justified in that it maintains confidence in the system, but don’t ask me to explain the giveaways we’ve seen, because I have no idea. I’m just a lowly peon.

44

Hmm. If that’s the case, if I was Irish, I’d be royally pissed. It’s one thing to use government funds to temporarily float the system in order to unwind it in an orderly fashion. It’s quite another to expect people to put up with tax increases and service cuts in order to guarantee private debts in full. That’s bullshit.

45

Nobel prize winning economist Paul Krugman basically says the same thing here (requires a free subscription to the NY Times or you can search on Krugman Irish. A couple of excerpts:

"**Then the bubble burst, and those banks faced huge losses. You might have expected those who lent money to the banks to share in the losses. After all, they were consenting adults, and if they failed to understand the risks they were taking that was nobody’s fault but their own. But, no, the Irish government stepped in to guarantee the banks’ debt, turning private losses into public obligations.

Step back for a minute and think about that. These debts were incurred, not to pay for public programs, but by private wheeler-dealers seeking nothing but their own profit. Yet ordinary Irish citizens are now bearing the burden of those debts**."

Ireland is in a tough spot: bail out the bankers that enabled the bubble and take serious pain, or let the bankers go bust and take serious pain.

46

Whether you think it or not, this is a hugely controversial idea. I might agree with it if we could trust people to go for the full Ketynes, but as I said, I believe it too risky and too liable to being turned into another special interst porkfest. But even then, you face several problems.

First, the government might not actually have the money, or be able to borrow it.

Second, the money might just be thrown into a bottomless pit: just because you are “spending” does not in any way mean you are “creating value.” This small but vital distinction has consistently eluded governments throughout the ages. So many people fail to understand that money is worthless: it’s the value that we want and need. Bureaucrats and Congressmen almost never see this. They are focused on the outgo as wellt they should be), not on what the results.

Third, even if you could spend it usefully, you have to consider the payback. As a practical matter, this is basic finance - the kind of thing taught in any colege intro course. Unfortunately, the people making decisions are lawyers and know jack-all about it. This is a little hard to explain, so I’ll set and example:

In the end, any money you drop in the system has to be pulled out in taxes. Unless the government just happens to have a pile of money in the bank, you’ll borrow it and pay it back. Anything you borrow in lean times will then have to be paid back, plus interst, in flush ones. This gets really tricky, because you can’t ever know what your real rate of return will be. Will the taxation required to make ends meet wind up destroying your flush times? Are you really “kick-starting” the economy by putting money in, or is that just a temporary boost which immedaitely goes away once you stop pumping in cash? Sadly, the evidence these days points me towards the latter: you can tase a coma patient, but that won’t wake him up.

To me, this is part of the bad conception of the economy too many people and politicians have. The economy to most looks like an engine. You just put in more fuel, right? And maybe add some oil and polish the part, right? Well, no. It’s an ecosystem with diverse, and sometimes unpleasant forms of life. You can try to cull some species, but the successful ones usually manage to survive in spite of you, and are often neccessary to its functioning. The whole system will sometimes spark a forest fire, and by stopping that you wind up with bigger, much more devastating ones later on. This is a big part of the Greenspan criticism: he created a system which was bound to fail eventually and would eventually be worse when it did. And like an ecosystem,. it’s full of evolving life, changin at a rate we can hardly keep up with.

Finally, China Guy, I’d avoid using Paul Krugman as a source for anything. He’s gotten so heavily political that he routinely changes his opinions, often in ridiculous way, to match his opinions. I don’t dismiss his Nobel-winning theory out of hand. But he’s a dubious source and has been for many years. He’s very fond of cherry-picking his data as well. These days, Krugman is a columnist and media personality, and lies far from any honest science. Let’s just say that every event is always proof Krugman is right. I don’t think he’s deliberately dishonest, but he certainly doesn’t have a very long memory and he very much colors his perceptions to his opinions.

47

Not really, unless you’re advocating for the strong form of the Treasury view because you have an ax to grind against government spending. But not even Milton Friedman was willing to go that far.

The basic measure of GDP by expenditure is:

GDP = Consumption + Investment + Government spending + Net trade

If consumption and investment spending decline, and government spending and the trade balance stays the same, then GDP must decline. That’s just math.

48

You are absolutely right-and a big part of the reason (that Greece is just a tourist economy), is that Greece opened its market to cheap imports (China). Before the 1980’s, Greece had thriving small factories that made shoes, clothing, electrical fixtures, and other consumer goods. Cheap Chinese imports put these factories out of business-and the “solution” was to bump up the government payrolls. Today, the Greek government employs thousands of people who do little or nothing-and the Greek bureaucracy is one of Europe’s worst (try getting a building permit).
So, the "free trade’ really caused the collapse of the Greek economy-and that is facing the USA as well.

49

That very obviously is not what smiling bandit was saying was a controversial idea. He’s not arguing agains tht ebasic GDP calculation, he’s saying that it’s not universally accepted as true that the government MUST spend its way out of recession. It’s true that logically this would mean that the GDP would have to go down for at least some period of time, but why is it axiomatically true that the government must do anything possible to prevent GDP from going down for some period of time? It might well be a better move to let it go down by X if that means in the longer term it will increase by Y.

Keynesian theory is great but experience shows that those who all about Keynes in bad times tend to conveniently forget his name when the economy’s doing well.

I also have to concur with smiling bandit about the never-ending name-dropping of Paul Krugman in these things. It’s hard these days to have a thread without someone citing “Nobel Prize winner Paul Krugman” as the end of the debate. Paul Krugman is certainly ten times the economist I am, but

  1. I notice nobody ever cites “Nobel Prize winning economist Milton Friedman” or “Nobel Prize winning economist Amartya Sen” or “Nobel Prize winner Gery Becker.” If I started throwing around Milton Friedman as a backstop to my arguments I’d be rightly pilloried for arguing from authority. If I started using the work of Edmund Phelps to argue that Keynesian theory has a lot of gaps in it I’d probably get nothing but silence, because, well, it just wouldn’t be popular to say that, and Phelps doesn’t have a Times column.

  2. The only reason Krugman is getting pulled out so often, as opposed to (insert economist here), is that (a) he’s in the New York Times a lot, and (b) he’s adopted a political stance that’s convenient to call upon if you don’t like big business.

It’s not that I’m saying Krugman is always wrong, or even often wrong, or necessarily wrong at all, but Krugman’s NY Times columns are opinion, not science. His statements are either true or not true, honest or manipulative, politically biased or not, irrespective of his having won a Nobel Prize.

50

No, he disputed my contention that a drop in business and consumer spending must be matched by a rise in government spending (assuming no change in the balance of trade) if GDP is to be held stable. The rest of his post was a screed about the dangers of government malinvestment and crowding out, which is where I said the actual debate over government spending should occur. The belief that government spending can have no effect at all on GDP and unemployment is pure Treasury view, and inapplicable to anything other than a barter economy in its strong form.

I’m not sure why you seek to hijack the thread with more uninformed complaints about Paul Krugman, as this thread isn’t about him and you gain no credibility by dismissing his expertise.

51

Your hidden assumption is that you even have the ability to hold GDP stable in this manner. I’ve been arguing from the beginning that in a ‘balance sheet’ recession it’s not clear that government can prop up GDP like this, because increases in borrowing by the government may just cause further reductions in private spending.

If the reason private spending is falling is because of lack of confidence in the future fiscal health of the nation as a whole, then attempts to prop up GDP through even more borrowing could make the situation worse, or at least not improve it by as much as you think.

No one has said that government spending will have NO effect. The question should properly be framed in a longer term - ten years out, will you have been better off overall for having engaged in a lot of stimulus? Even the CBO says that the 10-year effect of the stimulus is likely to be -0.3% of GDP, meaning that there’s a definite long-term cost even under their Keynesian assumptions that accept the kind of multipliers Krugman and co. believe. If in fact the multipliers are smaller, the net effect of the stimulus will be quite bad, and your kids would have been much better off had you not done it at all.

A 1 trillion stimulus leaves the next generation with a 30-100 billion dollar a year interest payment, that will continue on until the government pays off the debt (not likely in mine your your lifetime). That’s 30-100 billion that can’t be spent on social programs, education, defense, or left in people’s pockets as tax savings.

For that to be a reasonable tradeoff, the stimulus has to prevent the destruction of a whole lot of wealth, and has to return real-world multipliers that match theory. So far, that doesn’t look to be the case.

The ultimate rationale for Keynesian policy is to protect productive assets from being destroyed by a temporary downturn. Once you get to the point where the cost of the stimulus is greater than the loss of assets avoided, you’re acting counter-productively.

The malinvestment issue is also important. If the stimulus diverts investment and energy away from productive assets and into digging holes and filling them in, you may be able to prop up GDP temporarily, but once the money is spent you have fewer factories and more filled in holes, and the economy suffers.

Just as you gain no credibility by merely citing him. If he were the spokesman for the smartest economists on the planet, maybe an appeal to his authority would be worth something. But since there are many Nobel-winning economists who flatly disagree with his policy prescriptions, using him as an appeal to authority is worthless.

52

Uh, no. No I didn’t, and if that’s what you meant, you wrote in a grotesquely poor manner. You said absiolutely jack about GDOP staying the same. Let’s recap:

“As to the OP: well, it’s simply economics. If business and consumer spending plummets, then government spending has to pick up the slack.”

You may have meant the theoretical approach, but nowhere in the entire post was that clear (to anyone, given the other responses), and that’s not even the real thrust of the OP, either. You may not have meant it that way, but your actual sentence is normative, not analytical. And there is a big argument over it still, because people aren’t even sure if the GDP jump you get from more government spending represents any kind of real economic activity or just the electrified corpse twitching.

Because his arguments flex with the political climate and not changing facts. He’s a bad cite, and I’ve avoided using him even when we do agree.

53

Ireland is in a recession. Business and consumer spending has fallen. Assuming no significant change in their balance of trade, what’s left that can prevent a fall in their GDP? If your answer is “nothing,” then you’re espousing the strong form of the Treasury view.

54

Keynes pointed out “in the long run, we are all dead”. Suppose you had a perfect solution to the economic and government debt problem, which had the side effect that for the next ten years 50% of the population would be homeless and 5% would starve to death? For a hardened alcoholic, one more drink can be the lesser evil when the alternative is going into D.T.s. On the other hand, systemic problems can’t be solved without at least some short-term pain. So where do you draw the line?

55

Sorry to be hideously pedantic but there is no ‘Nobel prize in economics’. There’s a *Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel *established in 1968 by the Swedish central bank. But that has nothing to do with Alfred Nobel and the prizes set out in his will. It really bugs me how this is equated with the actual Nobel prizes.

Back to Ireland and the austerity measures… Here’s a rather sad and angry commentary from an Irishman. It’s not looking too good.

56

I think most people know this, but “Nobel Prize” is a hell of a lot easier to type.

Also, the Economics prize is, after all, decided upon by a committee struck by the Nobel Symposium. It’s officially affiliated with the Nobel Foundation. So while it waswn’t one of the Awards endowed by Nobel, it falls under the purview of the Nobel Foundation, and it’s a prize, so calling it a “Nobel Prize” is reasonably accurate.

57

I’m not so sure that many people do know the difference.

The Swedish Bank prize may ape and mimic the selection and nomination processes of the Nobel prizes in chemistry and physics but the fact remains that it is not one of the prizes established by Nobel in his will. Rather it is an award that was intentionally created to reflect the prestige accorded to the actual Nobel prizes.

I find the Friedrich Hayek’s criticism of the prize particularly apt:

(quote from wikipedia page on the prize)

And the disagreement between Sam Stone, **Smiling Bandit ** and MOIDALIZE about arguments to authority seem to reflect Hayek’s point. Calling this prize the ‘Nobel prize in Economics’ gives the recipients an unwarranted cachet which is frankly somewhat dangerous.

58

What would the ten year drop in GDP be with no stimulus?

The government can currently borrow a trillion dollars for five years at negative interest, investors will lend them money at 0.5-1% below expected inflation over the five years. The government can borrow a trillion dollars for ten years for a real yearly payment of about five to ten billion dollars. But when they borrow this money and increase GDP with it, the increased GDP would easily increase revenues far in excess of the interest payment, even when interest rates increase as the economy improves.

Stimulus isn’t diverting investment from anything. There’s almost no investment going on right now, business is sitting on its hands with massive excess capacity and no consumer demand to make it worth investing even if they didn’t have existing assets standing idle.

There are many top economists who disagree with Krugman. But these are the same guys who told us that markets can regulate themselves and the government just needs to get the hell out of the way and let the invisible hand bring us all unparalleled prosperity. These guys are still clinging to a busted ideology that says any government involvement in the economy is a bad thing so the government shouldn’t get involved and if they do it’ll make things worse, so there’s no way their ideology lets them agree with Krugman, a guy who has been substantially right about the bubble, the meltdown and its aftermath. I’d personally rather go with the guy who’s been substantially right about everything rather than they guys who’ve proven to be a bunch of fuckwits.

59 
No, that's not what the CBO report says. Here is the pdf [file](http://www.cbo.gov/ftpdocs/100xx/doc10008/03-02-Macro_Effects_of_ARRA.pdf). First of all it gives two estimates: low impact and high impact. In the low impact the stimulus increases GDP by 1.4, 1.1 and 0.4 % in the first three years relative to the baseline and then in the later years GDP is lower by 0.2% in the years 2016 to 2019. In the high impact estimates, GDP increases by more in the early years and there no negative impact in the later years. Frankly even the low estimate numbers seem like a pretty good deal especially since the CBO says the stimulus will create a couple of million jobs in the first two years without having any negative impact on employment in later years.

And note that the negative impact mentioned already incorporates the crowding out effect because of higher debt levels. You can’t consider interest costs again as a separate cost.

And I am not sure what the “Even the CBO” part means. These are fairly conservative estimates using standard macroeconomic models. They may be wrong of course but they are probably the best estimates we have got. Doug Elmendorf is a highly respected economist who, for example, has worked under the conservative economist Martin Feldstein and worked at the Fed under Alan Greenspan. If there is another equally detailed study of the impact of the stimulus which you prefer please post it.

60

Krugman is not God, but he has been on the mark more than his detractors.