This is a key moment in the story:
... where the onset of the Great Depression was accompanied by policies that intensified the slump—interest rate hikes in an attempt to hold on to gold reserves, spending cuts in an attempt to balance budgets—2008 and 2009 were characterized by expansionary monetary and fiscal policies, especially in the United States, where the Federal Reserve not only slashed interest rates, but stepped into the markets to buy everything from commercial paper to long-term government debt, while the Obama administration pushed through an $800 billion program of tax cuts and spending increases. European actions were less dramatic—but on the other hand, Europe’s stronger welfare states arguably reduced the need for deliberate stimulus.Instead, a faith-based enthusiasm for austerity policies, unhinged from actual evidence that such an approach would be anything but harmful in a depression, took hold in both Europe and the US. As Krugman puts it, "Standard textbook economics says that slashing government spending reduces overall demand, which leads in turn to reduced output and employment." So it's not as though nobody knew this was a bad idea. But the crowd Krugman has labeled the Very Serious People - which is probably going to be a lasting contribution of Krugman's to American English - thought otherwise.
Now, some economists (myself included) warned from the beginning that these monetary and fiscal actions, although welcome, were too small given the severity of the economic shock. Indeed, by the end of 2009 it was clear that although the situation had stabilized, the economic crisis was deeper than policymakers had acknowledged, and likely to prove more persistent than they had imagined. So one might have expected a second round of stimulus to deal with the economic shortfall.
And they found economists who were telling them what they wanted to hear, two significant pairs of whom Krugman discusses in this essay, Alberto Alesina and Silvia Ardagna, and the duo that recently became world-famous for an Excel coding error, Carmen Reinhart and Kenneth Rogoff.
And Herbert Hoover/Heinrich Brüning got an excellent real-world test. Unfortunately for most of those who experienced it. And the support from the economics profession that allegedly supported the policy proved to be built on sand, or had feet of clay, or blew away like stray in the wind, whatever metaphor you prefer:
Three years after the turn to austerity, then, both the hopes and the fears of the austerians appear to have been misplaced. Austerity did not lead to a surge in confidence; deficits did not lead to crisis. But wasn't the austerity movement grounded in serious economic research? Actually, it turned out that it wasn't—the research the austerians cited was deeply flawed.It is a tribute to the power of stories that austericide economics got such a hearing. But it was more a tribute to the influence of the very wealthy who, for reasons that may in some ways have been partially rational and in other just plain misguided, supported austericide. Krugman puts it this way:
First to go down was the notion of expansionary austerity. Even before the results of Europe’s austerity experiment were in, the Alesina-Ardagna paper was falling apart under scrutiny. Researchers at the Roosevelt Institute pointed out that none of the alleged examples of austerity leading to expansion of the economy actually took place in the midst of an economic slump; researchers at the IMF found that the Alesina-Ardagna measure of fiscal policy bore little relationship to actual policy changes. "By the middle of 2011," Blyth writes, "empirical and theoretical support for expansionary austerity was slipping away." Slowly, with little fanfare, the whole notion that austerity might actually boost economies slunk off the public stage.
Reinhart-Rogoff lasted longer, even though serious questions about their work were raised early on. As early as July 2010 Josh Bivens and John Irons of the Economic Policy Institute had identified both a clear mistake—a misinterpretation of US data immediately after World War II—and a severe conceptual problem. Reinhart and Rogoff, as they pointed out, offered no evidence that the correlation ran from high debt to low growth rather than the other way around, and other evidence suggested that the latter was more likely. But such criticisms had little impact; for austerians, one might say, Reinhart-Rogoff was a story too good to check.
So is the austerian impulse all a matter of psychology? No, there’s also a fair bit of self-interest involved. As many observers have noted, the turn away from fiscal and monetary stimulus can be interpreted, if you like, as giving creditors priority over workers. Inflation and low interest rates are bad for creditors even if they promote job creation; slashing government deficits in the face of mass unemployment may deepen a depression, but it increases the certainty of bondholders that they’ll be repaid in full. I don’t think someone like Trichet was consciously, cynically serving class interests at the expense of overall welfare; but it certainly didn’t hurt that his sense of economic morality dovetailed so perfectly with the priorities of creditors.I wonder if it's conscious irony on his part that after dismissing the deeply-ingrained habit of looking at economics as a morality play, in his concluding section he uses the language of "sin" to describe the failings of the economics profession around the current depression.
It’s also worth noting that while economic policy since the financial crisis looks like a dismal failure by most measures, it hasn't been so bad for the wealthy. Profits have recovered strongly even as unprecedented long-term unemployment persists; stock indices on both sides of the Atlantic have rebounded to pre-crisis highs even as median income languishes. It might be too much to say that those in the top 1 percent actually benefit from a continuing depression, but they certainly aren’t feeling much pain, and that probably has something to do with policymakers’ willingness to stay the austerity course.
Tags: austerity economics, paul krugman