The boom, not the slump, is the right time for austerity

Alan Taylor has a piece on Vox today that is a nice contribution to the debate on the output effects of austerity. That debate has largely been about the endogeneity of fiscal policy: the more you take this into account, the more contractionary austerity becomes. He and Oscar Jorda show that if you give less weight to episodes where the austerity/no austerity policy choice was more predictable (i.e. more endogenous) and more weight to episodes where the policy choice was less predictable (i.e. more exogenous) then you find that austerity was extremely contractionary in slumps. This does not mean that fiscal consolidation is never necessary, but that the time for consolidation is when times are good, not when times are bad. It would be nice if Austerians could display a similar recognition that context matters.

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35 thoughts on “The boom, not the slump, is the right time for austerity”

  1. Second, we assume that policymakers care about timing fiscal adjustments so as to mitigate damage to the real GDP path of the economy; this is, at least, an oft-stated goal of most policymakers.

    That seems like a weak point in the analysis. There’s a political business cycle. If a government thinks it has enough time until the next election, it will frontload austerity so as to have a feelgood factor in place by the time it’s election season. Arguably the Tory LD Coalition is doing this.

    BUT if the government thinks that the next election is already lost but the one after is winnable, you dump the austerity onto the next government. Several Eurozone countries including Ireland might fit this description (note for example the number of poison pills left to the FG/Lab government by FF — Croke Park renewal, the prom note, the property tax).

    I don’t know how these timing issues affect their model but it would seem to complicate identification.

  2. Behold, there come seven years of great plenty throughout all the land of Egypt:
    And there shall arise after them seven years of famine; and all the plenty shall be forgotten in the land of Egypt; and the famine shall consume the land;
    And the plenty shall not be known in the land by reason of that famine following; for it shall be very grievous.
    And for that the dream was doubled unto Pharaoh twice; it is because the thing is established by God, and God will shortly bring it to pass.
    Now therefore let Pharaoh look out a man discreet and wise, and set him over the land of Egypt.
    Let Pharaoh do this, and let him appoint officers over the land, and take up the fifth part of the land of Egypt in the seven plenteous years.
    And let them gather all the food of those good years that come, and lay up corn under the hand of Pharaoh, and let them keep food in the cities.
    And that food shall be for store to the land against the seven years of famine, which shall be in the land of Egypt; that the land perish not through the famine.

  3. But in Ireland’s case, which boom is the time for austerity? The last boom, certainly, but that boom already ended, so it is too late to change policy for then. The next Irish boom? There might not be another fast-growth period in Ireland for, who knows, ten years? That is a lot of debt in the meantime.

  4. I think some thinking from aeronautical science rather than the Bible might be helpful.

    Assume that an indebted economy is an aircraft and it is slowing down to the point that a stall is about to occur! Pulling back on the joystick – instant real “austerity” – will ensure with certainty that the stall occurs. This is not in the interest of either debtors or creditors.

    The other approach is a recognition of the need to nurse the aircraft back to flight speed, the Irish bailout being a classic example – up to this point at least – of a controlled recovery.

    The situation of each aircraft is different; load weight on take-off, engine power, crew capacity etc., etc.

    The pursuit of a general scientific explanation applicable in all flight crisis circumstances seems unlikely to ever arrive at a scientifically provable result.

  5. Growth. Bank of Ireland are forecasting 0% this year and the Squid is worried about regions other than the USA.
    Meanwhile Paul Krugman thinks the Chinese Ponzi bike may hit BRIC wall
    http://krugman.blogs.nytimes.com/2013/07/20/how-much-should-we-worry-about-a-china-shock/

    New normal? So austerity will have to continue in less than boomy times.

    @DOCM
    Re your aircraft analogy.
    We’re at stall speed (0%)and the load factor keeps increasing (210b). Only option is to jettison some of the load.

  6. @ Flj

    I had not seen your post before posting the above. The great advantage of the analogy is that it is just that! What constitutes flight speed is nor subject to the actual laws of aerodynamics. It is a political calculation.

  7. @ Flj

    Having just read the piece by PK, the immediate question that comes to mind is; what is the connection between China and a Ponzi scheme?

    This comment on the shaky nature of the political structure in China is just as questionable.

    “Finally, politics and international relations. I am obviously no kind of expert here. But it’s obvious, first, that China’s political regime is remarkable, even given the annals of history, for the hypocrisy of its position: officially it’s building the socialist future,in practice it’s presiding over a crony capitalist Gilded Age. Where, then, does the regime’s legitimacy come from? Mainly from economic success. Let that success falter,and then what?”

    To quote Mao Zedong; “Political power grows out of the barrel of a gun.” It seems unlikely that China’s leaders have forgotten this maxim.

  8. Where does Ireland or any other highly indebted sovereign borrow from and at what rates. Without official support we could not run double digit/GDP deficits since 2008.

  9. Ireland has been borrowing at very low interest rates largely from the ECB. On the one hand the ECB saved Ireland and on the other the ECB allowed the Irish government to drag its feet on structural reforms. The ECB has anxiously tried to “save” Ireland with funds and praise. We are the prodigal son that cannot be allowed to fail otherwise the rest of the siblings do not have a hope in hell.
    A. Merkel harps on that being lenient with the debtors will allow them to backslide. While we do not like what she has to say we must recognise that she is displaying good business judgment.

    The question being asked above is are we past the point of no return on the slippery slope at 137% debt to GDP. It is a most important question and there is no doubt but we are closing in on that critical juncture.A continued low cost of borrowing and healthy growth in the EU are critical to our success. Contingency plans no doubt are in place covering the most likely outcomes. It would help if the Government made public the range of scenarios it has developed.

  10. California, Alan Taylor’s home state and the ninth largest economy in the world after Italy, has struggled with austerity for some through good and bad times. However, austerity does not happen in boom times, even in a one-party country such as China.

    Jerry Brown was a young governor of California in 1978 when nearly two-thirds of California’s voters passed Proposition 13, reducing property tax rates on homes, businesses and farms by about 57%. It mandated two-thirds majorities in both houses of the legislature to approve revenue rises. Spending only required simple majorities.

    As with the pattern elsewhere, the situation had to become so dire that Governor Jerry Brown, a Democrat, was forced in 2012 to slash 17% of his entire discretionary budget, mainly hitting the poor. On education, last November he gave voters the choice: either $6bn in cuts or a tax hike and 54% voted for tax rises.

    Brown said last month that he expected to report a budget surplus in 2014.

    When could Italy have enacted policies that could have promoted sustainable growth in the long-term?

    Italy had a budget deficit of 7.7% in 1995 but by 1998, a key year for approval of its euro membership, it had fallen to 2.7% without any significant changes in tax revenues or public spending, as ratios of GDP. Some Enron-style accounting with the help of derivatives was a short-term painless solution.

    It then effectively stagnated for a decade with average annual growth of 0.3% of GDP.

    In France in 1995, a Frenchman lamented the state of his country:

    “Over the past 20 years, little by little, the French people have divorced themselves from France. An economic crisis seemingly without end has broken for many the link of confidence that tied them to society. There is anxiety over unemployment and the risk of exclusion…Disquiet over a future that casts doubt on a belief inherited from the Enlightenment: that tomorrow will be more glorious than today, and sons happier than their fathers. It is not a matter of fatigue, nor malaise, but a veritable collective depression.”

    The words of Jacques Chirac, before becoming France’s president. By year-end, he withdrew retirement reform proposals in the face of massive strikes and lost the appetite for reform. In 2006, in his penultimate year as president, proposals to promote hiring of young people (under 26) were met with hundreds of thousands of students and workers on the streets. Chirac again folded.

    The situation is not dire enough for the current president to risk any material change.

    In Germany in 2003, Prof Hans-Werner Sinn’s book: ‘Ist Deutschland noch zu retten?’ (Can Germany be Saved?) was published. The book’s jacket had the summary:

    “Taxes keep rising, the pension and health insurance systems are ailing. More and more companies are going bankrupt or are leaving the country. Unemployment has reached alarming levels. Germany is outperformed by its neighbours. It’s growth rates are in the cellar, and it can’t keep up with Austria, the Netherlands, Britain or France. Germany has become the sick man of Europe.”

    It was dire and unemployment was heading for 5m during a boom period elsewhere.

    Reforms were enacted by the SPD-Green coalition.

    Christian Noyer, Banque de France governor, said this year that France “is one of the biggest spenders on employment policies in the developed world, but it still has one of the highest levels of unemployment.”

    He said that Germany “contracted almost twice as much as in France in 2009.” But Germany’s greater labour-market flexibility allowed for a much faster rebound. France lost 500,000 jobs in that period, while German unemployment ‘remained stable,’ in part because businesses could cut working hours when growth slowed.

    The experience in Ireland is that despite a brutal recession, external pressure is needed to have long-overdue reforms enacted, if at all. Mistakes have been made in Greece but again how could a very corrupt system have the potential for change, other than in a recession situation?

    Bailouts or not, small economies in the EMU are dependent on foreign lenders.

    It’s just not realistic to say that money should be forthcoming on the condition that some future government would give attention to correcting domestic imbalances.

    According to Seamus Coffey’s calculations, Irish deficits in the period 2008-2013, excluding debt servicing and bank support, will amount to €60bn – almost half annual GNP.

    Elsewhere, DOCM has linked to an FT piece from another American academic, Mark Mazower, who asks:

    “But can Germany start to see itself as the indispensable pump-primer on a continental scale? Can it accept the responsibilities of leadership?”

    There are lots of menus without prices in circulation. Let’s have one with a price.

  11. Wolfgang Schäuble in Saturday’s Guardian

    “We Germans don’t want a German Europe”

    “Where do we in Europe stand today? Three years after the start of the first assistance programme for Greece, and about three months after we agreed on a programme for Cyprus, the picture is mixed. On the plus side, there are many encouraging signs from the crisis-hit countries in the eurozone. Labour markets and social security systems are being reformed; public administration, legal structures and tax regimes are being modernised. These efforts are already bearing fruit. There is more competitiveness. Economic imbalances are shrinking. Investor confidence is returning.”

    http://www.guardian.co.uk/commentisfree/2013/jul/19/we-germans-dont-want-german-europe

    Wolfgang Schäuble interview with Spiegel, Nov., 2010.

    “And I also have great respect for the Greek government’s resolve. A few months ago, hardly anyone would have believed that the Greeks would manage to implement such a drastic austerity program. They’re moving in the right direction now.”

    http://www.spiegel.de/international/world/interview-with-german-finance-minister-schaeuble-the-us-has-lived-on-borrowed-money-for-too-long-a-727801.html

    EU Commission GDP forecast, Autumn 2010 for Greece:
    2010: -4.2%
    2011: -3.0%
    2012: +1.1%

    Eu Commission GDP forecast, Spring 2013 for Greece:
    2011: -7.1%
    2012: -6.4%
    2013: -4.2%

    EU Commission Unemployment forecast, Autumn 2010 for Greece:
    2010: 12.5%
    2011: 15.0%
    2012: 15.2%

    EU Commission Unemployment forecast, Spring 2013 for Greece:
    2011: 17.7%
    2012: 24.3%
    2012: 27.0%

  12. @ GK

    The Greek euro aircraft was never remotely airworthy and should never have been allowed to take off in the first place. The best that can be expected is a controlled crash landing cf Colm McCarthy

    http://www.independent.ie/opinion/analysis/we-can-start-to-dig-ourselves-out-of-hole-by-building-houses-people-need-29436237.html

    (The addiction to building houses seems set to continue!)

    On waiting for Merkel, the choice for Germany, post the elections, will be between stumping up the cash or agreeing some form of eurobond. (Schaeuble, when asked a direct question as to whether he could guarantee that there would be no cash transfer, said he would make the maximum effort to ensure that this was the case!).

    Link provide by Philip Lane some time back!

    http://europa.eu/rapid/press-release_MEMO-13-635_en.htm

  13. DOCM
    Germany was and will always pay. Either via higher inflation, eurobonds, debt mutualisation, or lower exports consequent to a vastly overvalued Neu-DM if the whole thing goes pop. The german public, like most, are illserved by their politicians who pretend there is a domestically costless way out of this. Merkel is a giant at home but a pygmy abroad in political terms. History will not be kind to her.

  14. @ KO’R: “It would be nice if Austerians could display a similar recognition that context matters.”

    It would indeed -and a lot more folk besides. Perhaps academic folk either just forget the previous episodes of economic ‘austerity’ (psychological distancing) or just write, read, listen to, and believe their own latest bit of academic spinola – posing as invariant truth, to them! Does it matter? Yes it does, but only if you are holding the sh*tty end of that austerity stick.

    The awful vista is that such intelligent academic folk are seemingly so ‘thick’ – and persist in this thickness even in the face of contrary empirical evidence. Maybe they know the empirical evidence must be wrong – for how could their theory be wrong! Its barely credible to us others who just believe the evidence of our own eyes. Trouble is, those messianic academics cause no end of mischief and hardship to so many. How do you neuter such duffers?

    My belief, is that politicians need to have bouts of austerity for two (maybe more) reasons. To frighten their voters – “What we are doing is for the best. It would be a great deal worse – so, just follow the prescription”. And within the advent of a parliamentary election, they proclaim that, “That the economy is recovering and we can have an ‘expansionary’ budget – so vote for me!” This latter mendacious ploy usually works.

    Can you imagine any politician proclaiming that all day-to-day state spending will have to be met from current tax revenues? Neither can I.

    So, someday our debt laden ship of state gets overloaded below its Plimsoll Line – (lets have a nautical analogy!). Sets sail, encounters a Force 10 (economic) storm – and founders. That storm front is there, over the horizon. Fortunately our ship of state is still anchored in a protected bay.

    Rats jump ship!

  15. @ Gavin
    Great post. Shows just how stupid the Europeans are

    Some very good analysis and opinion in SBPost today. Govt can’t agree on cuts. Banks in major trouble. Can someone also tell me why the debt to GDP figures released during the week got so little attention. I thought the deficit figure was awful. Am I wrong? Maybe it’s not as bad as I think but I would love some analysis of it.

  16. @ Fiat: This ‘move’ into commodities was predicted some time back. Remember the spikes in staple foodstuffs and that experiment with crude prices. Its like playing with sweaty-gelly. You have to be real careful or it blows up in your face.

    Those financial critters are arrogant, ignorant and willful. Ordinary folk do not ‘eat’ Al, but they sure need fuel to cook with and something to cook. Why do you think Egypt is in such a state? Fuel and staple foodstuffs are getting harder to come by. The financials can play Ducks-and-Drakes with western, developed economies, but it would be most inadvisable to try the same commodity chicanery on third-world countries with large (mostly poor) populations. They riot!

    @ Eureka: The official stats are so thoroughly pasteurized, homogenized and ‘massaged’ that it would be next to impossible to analyze them. You need to gather your own raw data – to be sure. Just keep taking those liberal doses of Skeptism. You’ll be fine!

  17. @Eureka

    I have to concur with Brian Woods Snr. I highlighted the different figures we are being fed by the NTMA and the CSO. Clearly the CSO have no axe to grind so I will go with their figures.

    An interview with the former IMF mission chief (Modi) on RTE now is most interesting. Essentially he is saying that we have overdone austerity and that the full 3.1 cuts planned should be abandoned and a growth strategy be enacted. He also said there is no case in the world where austerity resulted in a reduction of debt.
    Worth listening to for an objective expert opinion on the way forward. Perhaps MN is listening to him.

  18. @ Fiat: That interview has effectively torpedoed all the Austerian crooners, shills, and spinners. They’re fish bait. Watch the ‘backlash’. We need PR Guy to help us with the ‘interpretations’ of the interview. It would be Marxian (as in Groucho) except that so many have had to suffer so much for so long.

    MN listening? Hardly. Maybe. But some Labour backbenchers have just been handed a steel hurley. Lets see if they can apply it to their boss’s shins!

  19. Rte updated its page with the gist of the Modi interview…I think it’s worth repeating …if only for posterity..
    “A former senior official of the International Monetary Fund has said that Ireland should consider greatly reducing policies of austerity.
    Former IMF chief of mission to Ireland Ashoka Mody said there has been little growth in the Irish economy both this year and last year, adding it was hard to believe that austerity was not part of the problem.
    He said there was an immediate need for innovative alternatives to austerity.
    Prof Mody has said the Government should consider suspending or at least lowering Ireland’s planned cuts for Budget 2014.
    Speaking on RTÉ’s This Week programme, Prof Mody was asked if Ireland should reduce the deficit in 2014 to 5.1% or by the cash amount of €3.1bn.
    He said: “If a €3.1bn reduction is planned, then that number should be considerably lowered. I would even ask the question why can we not consider the possibility for the next three years, as an experiment, there be no further fiscal consolidation”.
    He expressed concerns that international growth prospects were poor in the short term, as was possibility of a reduction in Irish debt.
    He said: “The only instrument left to address the growth side is the fiscal instrument and that requires a complete rethinking of how aggressive and how persistent the austerity has to be.
    “At this point it looks like, given the debt dynamics, if debt levels remain where they are and growth remains where it is, there is never going to be a reduction in the debt ratio the foreseeable future and so logically we are left with the only other option: Generating growth by abandoning the sever commitment to austerity and hoping there will be a short-term boost to growth, which not only improves growth, but brings down debt levels”.
    Questioned about how important it was for Ireland to have legacy debt dealt with through the European Stability Mechanism, Prof Mody said: “The likelihood that legacy debt will be financed by the ESM is almost zero. At this time the politics of financing legacy debt is such that I would be astonished if that happened.”
    Asked whether Ireland should invest the €1bn Anglo Irish Bank promissory note savings in stimulus measures, the former IMF mission chief said: “I think that’s the very least that one should be thinking about … moving away from austerity at this stage is a sensible course of action and that if it is to be done, not just on the margins, by taking advantage of short-term windfalls by promissory notes and suchlike, but in a more well-conceived and well articulated way, such that it becomes a programme and not just a series of ad-hoc measures”.
    Prof Mody also expressed the belief that the Government was committed to future austerity, independently of any Troika programme: “If this programme did not exist, it’s unclear to me whether the Irish authorities would do anything differently”.
    Prof Mody also said a so-called back-stop, or fall-back credit facility was not vital to Ireland establishing credibility in the markets during the country’s exit from the bailout.
    “My view on that is it doesn’t hurt, but it’s not important.””

    Interestingly, Eamon Gilmore says he is convinced we will get retrospective recapitalization through the ESM but not until next Easter next….in an article in the Sunday Times today.

    I think I’ll go with AJ on this.

  20. @ Flj

    Even in the middle of the silly season, it is hard to see the “meedja” make much of this contribution by Modi. (Where was he when the country needed real guidance from the IMF?).

    @ Brian Lucey

    I agree that history will not be kind to Merkel but she still has some way to run. The problem I find with criticism of German policy is that it readily morphs into the blanket variety. My comment relates solely to the case of Greece. The two countries share a long and fraught history. Many of the decisions taken in the larger European chancelleries have had a geopolitical aspect (including the sale of huge volumes of military equipment which Greece could never conceivably have afforded; not to mention the staging of the 2004 summer Olympics!).

    Germany does not always pay! Nor can it be expected to.

    FYI

    http://lci.tf1.fr/monde/europe/grece-le-fisc-oblige-100-aveugles-a-recouvrer-la-vue-8161269.html

  21. @DOCM
    You are very dismissive of Prof. Mody.
    Where was he when he was needed. He was here in Ireland implementing IMF/ EU and ECB policy which has subsequently been discredited.
    Clearly he is convinced that Austerity can be counterproductive and leads to reduced growth …as in Ireland. And no growth leads to no debt reduction..as in Ireland. GGD projected to be 210b this year, which would suggest an unsustainable trajectory. Simple arithmetic works sometimes.
    It’s time we listened.

  22. And interestingly the Times correspondent seems to have listened to all of the interview and did not unnecessarily edit….

    “There was “not one single historical instance” where austerity policies have led to an exit from heavy debt burden. Changing policies could possibly lead to growth, reduce debt levels and also prompt a “psychological boost” for the economy, he added.
    Mr Mody said the likelihood of Ireland getting money back form the European Stability Mechanism for its legacy banking debt was “almost zero”. “I would be astonished if it happens,” he added.”

    Will professor Honahan listen?

  23. DOCM
    Alas, i cant see how Germany can avoid paying. Have I missed a fifth alternative? Id love to see it if so.
    This isnt moralising – its logic. Mutualise debt issued, new debt issuance, accept inflation or see the thing collapse and watch over a period the DM-Neu rocket up. Whats choice 5?

  24. @ Brian Lucey

    I did not say that Germany would avoid paying. I intimated that Berlin will pay according to the circumstances of each case (which are very unlikely to include Ireland with regard to direct bank recapitalisation). Asking the German taxpayer to stump up the actual cash will not, however, be very popular; hence my belief that a limited tailored form of debt mutualisation, suitably camouflaged, will be found.

    That is the fifth choice!

    Your assumption appears to be that the malaise impacting the euro is the same across the board. It is not. Germany is, furthermore, as Michael Hennigan has pointed out many times, in a very strong position, the country’s export “pain threshold” being very high. This is not to suggest that Germany would be happy with the collapse of the euro. But the pips will have to squeak in the other major economies – notably France and Italy – long before such a scenario unfolded in Germany.

  25. @Frank Galton

    <assuming selflessness of governments> seems like a weak point in the analysis

    This is hardly a significant flaw though, Taylor’s study is about the counterproductive nature of austerity, not the self interest of politicians. In fact your observation serves as a better explanation of supporting austerity than delaying it.

    @Gregory Connor

    But in Ireland’s case, which boom is the time for austerity?

    Slightly lost here here as to why you see this as a problem.

    Since austerity seems on average to have negative results (even in a boom) it is a policy without a valid economic justification. The prudent time for austerity is never, at least according to the evidence.

    I think it is fair to say that austerity is a part of a long term political project by the right to shrink the state rather than a useful and necessary policy tool.

    @DOCM

    Did you not understand Gavin Kostick’s post?

    It was not about how dire the results of EU policy have been for Greece (the numbers speak for themselves), it was about about how foolish the European Commission looks – a 90% forecasting error is quite some achievement.

    These people are dangerous neoliberal clowns.

  26. Correct, of course.

    However, myopia on fictional reserve banking and wholesale theft by FIRE sector prevent that austerity from ever being adequate enough. The system is gamed to the extent that there is no market in truth, only in …. economics…… Stupidity is never punished when the Ponzi Bank is blowing the bubbles. Now, we only hear the bleating of those who never spotted a bubble in their lives…

    QE is about to expire. Then Ireland will experience austerity. Playing with deckchairs while the music plays on! What vanity is “economics”! You all deserve what your children are about to get.

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