De Rugy: Why "Balanced" Austerity Isn't Helping Europe—And Why Spending Cuts Just Might

Instapundit points to Reason columnist and Mercatus Center economist Veronique de Rugy's recent post at National Review's The Corner. It's her latest entry in an ongoing argument about what counts as austerity policy for governments and what sort of austerity is more likely to get a country's economy up and running again.

Characters such as Paul Krugman keep saying that austerity—by which they usually mean significant cuts in government spending—has been tried in Europe and has simply tanked the economies over there (and here). De Rugy has consistently made a few related points that Krugman, folks at the Wash Post and Economist, and elsewhere, have gotten around to acknowledging. Most European countries tried what's called "a balanced approach" to reducing debt and deficits. That is, they raised taxes (rarely a good idea and a really bad one during a weak or contracting economy as it punishes activity) while either cutting relatively small amounts of spending or simply promising to cut spending while in fact raising it:

Tax increases (private-sector austerity), especially in times of economic contractions, are never a good idea or a good way to promote growth. That's true even in a Keynesian model. Yet, we aren't hearing anti-austerity advocates complain loudly that Europeans are raising taxes. Where are the headlines saying, "Europe needs to stop raising taxes"? Instead, we read that spending, and the lack of it, is to blame for austerity. Maybe that's because acknowledging that austerity through spending cuts and tax increases has produced terrible results in Europe makes it hard to continue calling for tax increases–even if only on the rich–in the the US's weak economy.

De Rugy has marshaled research showing that the better austerity plan is to cut spending, which shows a country is serious about reforming ruinous policies, while pursuing related policies that allow an economy to catch its breath ("easy monetary policy, liberalization of goods and labor markets, and other structural reforms"). Her post is especially timely, as various analysts are urging Germany, which spent a decade folding the fourth-world economy of the former GDR into its operations and then tackled structural reforms in a way that very few European countries have managed, to start stimulus spending to help Greece and other basket-case nations in the euro-zone.

De Rugy notes that there are limits to what monetary policy can accomplish—"it is mistake to oversell it and it certainly won't achieve our long term goals without serious reductions is government spending"—which I think is right. We've had relatively easy monetary policy in the U.S. for a very long time, after all; what we haven't had is reduction in federal expenditures over the same period or clear signals that we're seriously pursuing the same.

Read her post, which includes great links to Scott Sumner's The Money Illusion blog, and watch this interview with her about European austerity and the failure of the "balanced approach" of tax hikes and little-to-no-spending cuts.

Comments

[buntpunt]

OK wow so why didnt I think of that?

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[Jerry]

I’m confused, because even Krugman thinks that printing money is a better option than increasing government spending. In the Eurozone this is not possible, so he falls back to increasing government spending. Sweden (which has its own currency) has followed a policy of easy money and fiscal restraint, inflation did the rest so that tax revenue increased and the budget deficit shrunk. But to me, this is still taxation, you’re just trying to fool people who would have opposed direct tax increases.

[Mo]

This kinda ignores that flat spending in a recession is a sign of austerity. Much of government social spending (like unemployment, food stamps, housing vouchers, etc.) is counter-cyclical. So if unemployment shoots up, but spending stays relatively flat, it means that social benefits had to have been reduced or qualifications were made more difficult. That is austerity, even if absolute spending isn’t sharply down.

If unemployment got cut in half tomorrow and there were no policy changes, total spending would go down. However, I would not call that outcome austerity.

[Mike M.]

There are two sides to Keynes’ theory of counter-cyclical spending, with the other side of the coin being that deficits are supposed to go down during the good times.

Well guess what: that never happened in much of the west during the most recent boom! Why do you think so much of Europe is screwed now with their credit ratings in the toilet? When deficits increase during the good times and then increase even more during the bad times, that’s not “counter-cyclical” government spending.

[Mo]

Don’t take my comment as a defense of Europe’s fiscal house and budgeting during the good times. However, to ignore the counter-cyclical triggers in existing law and state that reducing unemployment and welfare benefits in a recession isn’t austerity is a stretch. Would you call reductions in government tax receipts in a recession “tax cuts”, even though there’s no change in policy?

[Restoras]

Alt+text FTW.