The cuts Paul Krugman thinks caused a double-dip
recession don't exist
By ROBERT P. MURPHY
One of the problems with economic policy analysis is
that pundits on both sides create their own versions of reality. A good example
of this is economist Paul Krugman’s treatment of the British government’s
spending since the financial crisis. As a Keynesian, Krugman of course thinks
that massive government budget deficits are necessary in these times of
depressed demand and a “liquidity trap.”
To ostensibly demonstrate how right he is, Krugman has repeatedly
pointed to the British experience. According to Krugman, the Brits did what all
the right-wingers wanted, and slashed spending in order to rein in deficits.
Yet this led to a double-dip recession, just as Krugman warned. There’s just
one problem with this argument: The British didn’t actually cut spending, and
their fiscal pattern is quite similar to that of the U.S.
In a lot of ways George Osborne, the Chancellor of the
Exchequer (finance minister) is Britain’s answer to Paul Ryan. True, he’s a
toned-down version — no Ayn Rand, please, we’re British — but other aspects of
package are there in full force: he’s articulate, has a vision that’s
completely at odds with everything we actually know about macroeconomics, and
he was for a while the darling not just of the right but of self-proclaimed
centrists on both sides of the Atlantic.
Osborne’s big idea was that Britain should turn to
fiscal austerity now now now, even though the economy remained deeply
depressed; it would all work out, he insisted, because the confidence fairy would come to the rescue. Never mind
those whining Keynesians who said that premature austerity would send Britain
into a double-dip recession.
Strange to say, Britain’s recovery stalled soon after
Cameron/Osborne began their new policies, and the country is now in a
double-dip recession.
Now for Krugman’s story to really make sense, you would expect that the
United States had continued with Keynesian policy recommendations, in contrast
to the draconian budget-slashing of the British government. In that case, the
fact that the United States recovery—though tepid—continued through 2010 and
2011, while the UK fell back into official recession, would be prima facie
evidence in Krugman’s favor.
Yet as I said in the beginning of this article, the problem with
Krugman’s narrative is that the British
never actually cut spending. As so often happens in government, the
British merely slowed the
rate of increase, at least if we are considering all levels of
government combined. (Long-time readers of Krugman know that this is his
preferred metric. If I had focused on merely federal expenditures, then a
Krugman fan would accuse me of cheating.) Here is a chart showing absolute
expenditures in nominal terms (i.e. not inflation-adjusted) at all levels of
government in the United Kingdom, calculated with data from Eurostat and the Guardian:
It’s also revealing to compare the UK with the US, both in terms of
total government expenditures and total government budget deficits, as shares
of the economy:
As the above chart demonstrates, the total government budget deficits
(as shares of the economy) were quite similar throughout the crisis in both
countries. It’s true, the deficit in the UK was smaller in 2010 and 2011 than
in the US, but the contrast is hardly a stark one. If Krugman thinks the above
chart shows the folly of budget austerity, a conservative could just as easily
say it shows the dangers of excessive government spending, which was
consistently higher in the UK throughout the whole cycle.
I do not deny that some right-wing pundits pointed to George Osborne as
a role model before Britain fell back into recession, but to my knowledge they
were mostly journalists, not Chicago School or Austrian economists. Indeed, I
know that many in these camps explicitly warned against the
large tax rate hikes that the British government implemented in the name of
fiscal austerity. These economists could now pat themselves on the back with as
much justification as Krugman, and say they predicted that a tax hike on “the
rich” would backfire in the UK, raising less revenue because of Laffer Curve effects. Yet
Krugman himself has no problem with raising taxes on “the rich” in the US,
despite this apparently obvious lesson from overseas.
This episode underscores the ease with which economists can use data to
support just about any narrative they want. To take a well-known example,
Christina Romer and other Keynesian economists designed a stimulus package for
the incoming Obama Administration that was supposed to limit the rise in
unemployment to under 8 percent. When that prediction
turned out to be awful, the Keynesians explained it away by saying the economy
was worse than they realized. Krugman himself threaded the needle by (a)congratulating himself on predicting that the stimulus would be
too small while (b)praising “Big
Government” (his term) in the summer of
2009 for rescuing the economy from depression.
My point in all of this isn’t to accuse Krugman and other Keynesians of
willful dishonesty. Rather, my point is that they seem so sure that
the data are on their side, when they don’t see how their worldviews allow them
to deal with any problems. For example, in this article I show how Krugman literally had to
explain away at least 9 different examples (!) of governments successfully
engaging in fiscal austerity without wrecking their economies.
In macroeconomics, there are no controlled experiments. There are always
a million different things changing, and so a committed Keynesian can always
come up with a story such that the data “confirm” his worldview. This danger
exists for other economists too, but the great virtue of the Austrian School—of
which I consider myself a member—is that they seem more aware than others of the limits of empirical back-patting
in this arena.
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