The Pain of Austerity, Remedied by Keynesian Policy

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Here we go again. There’s now a full-court press of the usual suspects claiming that the recovery in Britain proves that fiscal austerity isn’t contractionary after all, that the International Monetary Fund had it all wrong, and so on.

The economist Jonathan Portes, director of the National Institute of Economic and Social Research, recently wrote an extended takedown on the organization’s blog; the simple version is that Prime Minister David Cameron’s government did a lot of fiscal contraction in 2010 and 2011, but then slowed the pace of consolidation dramatically. Unfortunately, uncertainty over how big Britain’s output gap (the difference between real G.D.P. and the economy’s capacity) really is makes it hard to agree on a measure of fiscal policy, but just about every measure does indeed show austerity tapering off sharply after 2011.

So the government did a lot of austerity, then stopped doing more, and the British economy began to grow thereafter. Does this vindicate expansionary austerity? To use an analogy I’ve used before, if I keep hitting myself in the head with a baseball bat, and then stop, I will start to feel better; this doesn’t mean that hitting yourself in the head with a baseball bat is a good thing.

If you read Mr. Portes’s piece, you’ll see that George Osborne, the chancellor of the Exchequer, and other British officials are engaging in some sophistry here, claiming that the government has never changed its plan, so it’s still on Plan A. That’s a very dubious claim, but in any case it’s irrelevant to the macroeconomic argument.

The fact is that Britain has done much less fiscal consolidation since 2012 than it did in the previous two years – so the economy’s performance since then is actually a vindication of Keynesian claims, whatever the government’s intentions.

Needless to say, I don’t expect any of this to make dent in austerian views.

Secular Stagnation Remains a Risk in the United States

The Congressional Budget Office has issued its latest budget update for the United States, and as always it’s a very careful piece of work. But there is one thing really worth drawing attention to – not that the C.B.O. is necessarily wrong, but it might be, and at any rate people should be aware of what’s driving the conclusions.

Here it is: the C.B.O.’s projection has deficits quite low in the near term, but starting to widen a few years from now. What’s driving that move toward deficit? To an important extent it’s interest payments, which the C.B.O. has rising from 1.3 percent of gross domestic product in 2014 to 3.3 percent of G.D.P. in 2024.

Well, that’s what happens when you have ever-growing debt, right? The more you owe, the bigger the interest payments, and up it spirals, right?

Wrong.

The C.B.O. has debt rising only slightly as a share of G.D.P., from 74 percent in 2014 to 78 percent in 2024. Essentially, that rise in interest burden reflects the assumption that the federal government’s borrowing costs will rise sharply as the economy normalizes.

But meanwhile we have another careful organization, the I.M.F., declaring that there is a long-term downward trend in real interest rates, that secular stagnation is a real risk and that rates not much higher than what we see now may be the new normal.

Who’s right? I’m with the I.M.F., but they and I could be wrong. The key point for now, however, is that the C.B.O. hasn’t exactly found that deficits will start to rise in a few years; it has essentially assumed that interest rates will rise much more than many economists, including those at the I.M.F., believe.