When I was young and naive, I believed that important people took positions
based on careful consideration of the options. Now I know better. Much of what
Serious People believe rests on prejudices, not analysis. And these prejudices
are subject to fads and fashions.
Which brings me to the subject of
today’s column. For the past few months, I and others have watched, with
amazement and horror, the emergence of a consensus in policy circles in favour
of immediate fiscal austerity. That is, somehow it has become conventional
wisdom that now is the time to slash spending, despite the fact that the
world’s major economies remain deeply depressed.
This conventional wisdom isn’t
based on either evidence or careful analysis. Instead, it rests on what we
might charitably call sheer speculation, and less charitably call figments of
the policy elite’s imagination – specifically, on belief in what I’ve come to
think of as the invisible bond vigilante and the confidence fairy.
Bond vigilantes are investors who
pull the plug on governments they perceive as unable or unwilling to pay their
debts. Now there’s no question that countries can suffer crises of confidence
(see Greece, debt of). But what the advocates of austerity claim is that (a)
the bond vigilantes are about to attack America, and (b) spending anything more
on stimulus will set them off.
What reason do we have to believe
that any of this is true? Yes, America has long-run budget problems, but what
Americans do on stimulus over the next couple of years has almost no bearing on
their ability to deal with these long-run problems. As Douglas Elmendorf, the
director of the Congressional Budget Office, recently put it, “There is no
intrinsic contradiction between providing additional fiscal stimulus today,
while the unemployment rate is high and many factories and offices are under-used,
and imposing fiscal restraint several years from now, when output and
employment will probably be close to their potential.”
Nonetheless, every few months
they’re told that the bond vigilantes have arrived, and they must impose
austerity now, now, now to appease them. Three months ago, a slight uptick in
long-term interest rates was greeted with near hysteria: “Debt Fears Send Rates
Up,” was the headline at The Wall Street Journal, although there was no actual
evidence of such fears, and Alan Greenspan pronounced the rise a “canary in the
Since then, long-term rates have
plunged again. Far from fleeing U.S. government debt, investors evidently see
it as their safest bet in a stumbling economy. Yet the advocates of austerity
still assure them that bond vigilantes will attack any day now if they don’t
slash spending immediately.
But don’t worry: Spending cuts may
hurt, but the confidence fairy will take away the pain. “The idea that
austerity measures could trigger stagnation is incorrect,” declared Jean-Claude
Trichet, the president of the European Central Bank, in a recent interview.
Why? Because “confidence-inspiring policies will foster and not hamper economic
What’s the evidence for the belief
that fiscal contraction is actually expansionary, because it improves
confidence? (By the way, this is precisely the doctrine expounded by Herbert
Hoover in 1932.) Well, there have been historical cases of spending cuts and
tax increases followed by economic growth. But as far as I can tell, every one
of those examples proves, on closer examination, to be a case in which the
negative effects of austerity were offset by other factors, factors not likely
to be relevant today. For example, Ireland’s era of austerity-with-growth in
the 1980s depended on a drastic move from trade deficit to trade surplus, which
isn’t a strategy everyone can pursue at the same time.
And current examples of austerity
are anything but encouraging. Ireland has been a good soldier in this crisis,
grimly implementing savage spending cuts. Its reward has been a Depression-level
slump – and financial markets continue to treat it as a serious default risk.
Other good soldiers, like Latvia and Estonia, have done even worse – and all
three nations have, believe it or not, had worse slumps in output and
employment than Iceland, which was forced by the sheer scale of its financial
crisis to adopt less orthodox policies.
So the next time you hear
serious-sounding people explaining the need for fiscal austerity, try to parse
their argument. Almost surely, you’ll discover that what sounds like
hard-headed realism actually rests on a foundation of fantasy, on the belief
that invisible vigilantes will punish us if we’re bad and the confidence fairy
will reward us if we’re good. And real-world policy – policy that will blight
the lives of millions of working families – is being built on that foundation.