UNC Everywhere

Right at the middle of the budget negotiations:

“There’s a standoff, and the staff hasn’t gotten anywhere. Rob Nabors [the White House negotiator], has been saying: ‘This is what we want on revenues on the down payment. What’s you guys’ ask on the entitlement side?’ And [the House Republicans] keep looking back at us and saying: ‘We want you to come up with that and pitch us.’ That’s not going to happen.”

Rob Nabors received his M.A. in political science from UNC before going to work in D.C. at the Office for Management and Budget. He was also the co-author of Thomas' most-cited paper (per Google Scholar).

Definitely Not Expansionary, Maybe Not Even Austerity

Dan Drezner has a post on whether we are now at a focal point that will discredit the idea of expansionary austerity:

The Greek sovereign debt crisis was another such focal point. Greek profligacy seemed to be a synecdoche for excessive government borrowing and lax fiscal discipline. With the global economy seemingly still in the doldrums, a lot of Europrean governments climbed on the "expansionary austerity" bandwagon. By the Toronto G-20 summit in June 2010, the consensus had switched from Keynesian stimulus to fiscal rectitude. Oh, sure there were mutterings about "short-term austerity makes no macroeconomic sense whatsoever in a slack economy" but even Barack Obama started talking about slashing government spending. 

Are we at another focal point? Consider the following: 

1) According to the New York Times' Stephen Castle, European leaders now seem to recognize that austerity on its own ain't working... 

2) The data is starting to come in on governments that have embraced austerity whole-heartedly, and it's pretty grim. Cue Paul Krugman on Great Britain:... 

3) Even commentators who would be tempermentally sympathetic with austerity are starting to bash Germany question whether it's a solution. Consider Walter Russell Mead:...  

4) U.S. 4th quarter data reveals that, consistent with GOP criticisms, the government has been the real drag on the U.S. economy. Not quite consistent with GOP criticisms: the reason why the government is dragging down the U.S. economy. Cue Mark Thoma:...

Before I get into this too deep, I should just note that I've always thought the accusations of belief in "expansionary austerity" from the Krugman/DeLong wing have always been something of a strawman.  The strongest view I've seen regularly expressed is that fiscal policy has essentially a null effect on growth because of forward-looking rational expectations, or because the central bank moves last, not that austerity will actually lead to expansion. I haven't even seen much supply-side voodoo being expressed lately. Can't recall the last time, actually.

First of all, I'd quibble with the claim that the G-20 ever climbed on the "expansionary austerity" bandwagon. Look at the Toronto Summit Declaration that Drezner mentions. No seriously, read it. There's a lot of language like "Unprecedented and globally coordinated fiscal and monetary stimulus is playing a major role in helping to restore private demand and lending" and "To sustain recovery, we need to follow through on delivering existing stimulus plans". Here's the first thing it says about budget deficits (emph added): "At the same time, recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, properly phased and growth-friendly plans to deliver fiscal sustainability, differentiated for and tailored to national circumstances."

To be fair, the next sentence advocates "consolidation" for countries with "serious fiscal challenges", but does that sound like doctrinaire Treasury View economics? Not to me, and certainly not for anyone outside of Club Med. And while Obama started talking about cutting government spending as Drezner notes -- not sure "slashing" is at all the right word -- other than token cuts all of the significant stuff was reserved for a few years down the road when the recovery was expected to well in progress. The Obama administration also thought in 2010 that growth was taking off; remember "Recovery Summer"? If they'd been right, it would be time to start thinking about cuts in the shortish-run future.

As for European views, it's possible that some people thought Greece's short run growth potential would benefit from austerity, but I don't remember much of that. After all, austerity is called austerity for a reason. All the talk I heard was about austerity as a sufficiently strong commitment mechanism that donors from the EFSF and IMF could be convinced that their transfers to Greece wouldn't be squandered, nor that they would be embedding moral hazard into the EMU that would encourage future profligacy. Now that may not be the best possible economic strategy, but this is a political game not an optimization problem, and in any case it doesn't follow from this observation that anyone believed that austerity would lead to expansion. The Germans cared about getting their money back, not generating growth in Greece, except to the extent that the two are related (and maybe not even that much). My recollection of the early discussions was that if European leaders believed in any of Krugman's oft-mentioned myths it was the "Confidence Fairy", not expansionary austerity.

And, while we're on the subject, the most recent proposal is for lots more austerity for Greece, with Germany taking over Greece's political system if they can't manage that themselves. It doesn't sound like the austerity consensus is at risk of breaking.

Regarding Great Britain and the United States, I'm not sure that the "austerity has failed" line is all that accurate. Here's Scott Sumner:

Here are the three biggest budget deficits of 2011: 

1. Egypt 10% of GDP 

2. Greece: 9.5% of GDP 

3. Britain: 8.8% of GDP 

A slightly more respectable argument is that the current deficit is slightly smaller than in 2010 (when it was 10.1% of GDP.) But that shouldn’t cause a recession. Think about the Keynesian model you studied in school. If you are three years into a recession, and you slightly reduce the deficit to still astronomical levels, is that supposed to cause another recession? That’s not the model I studied. ...

To get a sense of just how expansionary UK fiscal policy really is, compare it to France (5.8% of GDP), Germany (1.0% of GDP), or Italy (4.0% of GDP). Lots of people blame ECB policies for the recession, but Britain is not in the eurozone. Outside the eurozone you have Denmark (3.9% of GDP), Sweden (zero), Switzerland (1% surplus).

In other words, any "cuts" in spending have to be considered in context. Britain's cuts were from an insanely-high (and completely unsustainable) level to an exceptionally-high (and completely unsustainable) level. You can call that "austerity" if you like, and blame the lack of recovery on it if you like, or you could say that Britain has run historically high deficits in each of the last few years. Which is, pretty much, the opposite of austerity. (In any case, Cameron's administration knew that these cuts would not be expansionary, estimating that they'd cost more than a million jobs over five years.)

Similarly, with regards to the United States, Kevin Grier notes that "Federal spending is still [sic] than 30% higher than it was in January of 2007. State and Local spending is still around 12% higher than it was in January 2007. Is this really austerity? ... Can we really run a trillion dollar deficit and bemoan austerity simultaneously?"

I would tend to answer that question with a loud "No".* "Austerity" does not mean "not spending more on infrastructure". "Austerity" does not mean "not enacting a major jobs program". The U.S. did not continue to use fiscal stimulus at the same rate as the emergency measures taken in 2009, but that doesn't mean there's been all that much retrenchment. We haven't stopped mailing the food stamps. We haven't cut off Social Security payments. We haven't raised any taxes, and have cut quite a few. How is that austerity? Maybe that's not enough for Krugman's your taste -- and in fact I'd support higher deficits right now -- but fiscal transfers are political choices, subject to political pressures. Doing more now implies a greater burden for certain segments of the population later, and Obama's continued pursuit of a "millionaire's tax" and "Buffett rule" and "TBTF tax" and corporate tax reform and international corporate minimum tax just drives that point home.

So upper-income Americans don't have to believe in expansionary austerity to oppose further deficit spending; they just have to realize that when the bill does come due they'll be the ones paying it. They couldn't care less whether the fiscal multiplier is greater than 1 or not, because they won't be getting most of the benefit but will be paying almost all of the cost. Substitute "Germans" for "Upper-income Americans" and you're describing the Euro-crisis as well.

Drezner refers to an austerity "gospel", but I'm not seeing all that many true believers. I see it more as a competition between interests.

*Perhaps ironically, so does Krugman. From the article Drezner links: "True, the federal government has avoided all-out austerity" although he contradicts Grier by saying right after "But state and local governments, which must run more or less balanced budgets, have slashed spending and employment as federal aid runs out — and this has been a major drag on the overall economy". Grier provides data, so I'd tend to believe that he's more right, but Krugman usually doesn't make that sort of error so maybe a more nuanced perspective is needed.

Hard Keynesianism Is Not Politically Sustainable

Alex Tabarrok comes out in support of Hard Keynesianism:

... I propose an unbalanced budget amendment.

The unbalanced budget amendment is a requirement that in good times the government must run a budget surplus. The virtues of such a rule are that it allows for counter-cylical fiscal policy during a recession. Indeed, it reduces the cost of counter-cyclical fiscal policy because it guarantees a reserve fund for just such emergencies. The unBBA is thus a type of automatic stabilizer of the kind I have argued for before (e.g. here).

A simple version of the unBBA requires surpluses but more generally the rule would be a surplus or a similarly sized reduction from the previous year’s deficit. The size of the required surplus/deficit reduction would be tied to a function of current and recent GDP growth rates.

John Quiggin and Henry Farrell argued in favor of this sort of thing for the member states of the eurozone, which I discussed previously here and here. I will just add that most of the US states have a version of this requirement, and it mostly didn't help cushion them from this recession. In other words, this kind of rule is unnecessary for dealing with small recessions, and impossible to uphold during large recessions.

One technocratic argument in favor of an unbalanced amendment would be to prevent the sort of deficit build-up that commonly prefigure financial crises and/or recessions. Thomas may wish to say more about that. In general, I think the answer is that such an amendment will never be passed de jure for the same reason that the policy is not implemented de facto: there is no constituency for it, and there are plenty of constituencies for higher spending and/or lower taxes. States face legal fiscal constraints because everyone understands that in the end the federal government is on the hook, so there's moral hazard. The same dynamic does not apply at the national level.

Budget Politics

As threat of a government shut down looms and key players fight over the FY 2012 budget too, one might wonder, "have we have been here before?" We have indeed been here before, at least three times since 1965. The chart above highlights the path of the federal budget deficit as a share of GDP under the Johnson administration, the Reagan administration, and the George W. Bush administration. Each administration presided over a fairly large deterioration of the budget. Each deficit was generated by one of the three largest tax cuts in the American postwar era. Interestingly, tax cuts were followed quickly (within 18 months ) in each instance by a sharp increase in military spending (details and documentation here if you are interested). The combination pushed the budget into deficit.

Also interesting is how long it takes the budget to return to the status quo ante. Johnson and Bush took six years; Reagan took seven. Thus, if history is any guide, one shouldn't expect quick adjustment back to balance now.

Of greater importance is the politics of adjustment. Without exception, delayed fiscal adjustment was not a consequence of the failure to agree that adjustment was necessary. Instead, in each instance, the White House, the Senate, and the House leadership all agreed on the need for fiscal adjustment. However, they disagreed about how to adjust. One wanted to adjust by raising taxes and/or cutting military spending; one wanted to keep tax rates and military spending stable and cut non-discretionary spending. The resulting war of attrition delayed adjustment.

One might suggest that current events are the contemporary manifestation of a recurring pattern in postwar American politics. We cut taxes, we increase military spending, and then we fight about how to get back toward balance. Eventually, we get back to balance. And then we repeat the process again.

The most worrying element in all of this is consideration of the factors that ultimately spark agreement. In two of the three prior episodes, rather major episodes of financial instability sparked agreement on adjustment. A gold crisis in early 1968 (Time magazine called the crisis "the Greatest Gold Rush in History") broke the deadlock between the Johnson administration and Wilbur Mills. Black Monday of October 1987 (the single largest one-day "correction" in history) broke the deadlock between the Reagan administration and Congress. Let's hope that this time the players reach agreement before they trigger a major sell off.