‘Austerity’ Loses

Jobless rates haven't borne out the Krugman's fears, but he still knows he's right

By ROBERT P. MURPHY

Even the casual reader of Nobel laureate and New York Times blogger Paul Krugman knows that he has been screaming bloody murder about the foolishness of “austerity”—his term for even modest cuts in the growth of government spending, plus tax increases, to rein in budget deficits. The casual reader will also know that Krugman has been patting himself on the back many, many times (here’s one example from April 2013) since the crisis struck, saying that his Keynesian models have performed very well, while events in Europe and the US have clearly exploded the worldviews of his pro-austerity opponents. In this article, I want to explain exactly how Krugman keeps score on such matters, and why he always (apparently) comes out on top in the prediction game. To give you a hint, the game is heavily tilted in his favor.

In June 2010, for example, Krugman warned that “[m]any economists, myself included, regard this turn to austerity as a huge mistake. It raises memories of 1937, when F.D.R.’s premature attempt to balance the budget helped plunge a recovering economy back into severe recession.” However, Krugman was smart enough to cover himself, after raising the 1937 analogy, by ending with: “How bad will it be? Will it really be 1937 all over again? I don’t know. What I do know is that economic policy around the world has taken a major wrong turn, and that the odds of a prolonged slump are rising by the day.” So this is one part of his excellent defense: In terms of this column, the only way to falsify Krugman’s “prediction” is if all the European and US economies suddenly had robust recoveries in 2011. Who the heck was predicting that? Certainly none of the free-market economists going nuts over the awful policies in these regions.

Now when several countries across the Atlantic slid back into recession, Krugman was quick to say he told us so. In particular, he ridiculed British Prime Minister David Cameron who had argued that UK “austerity”—which is a ridiculous term, in my opinion, since Veronique de Rugy documents how hardly “savage” this austerity was—would reassure investors in the integrity of British debt and the pound. Krugman argued that the UK’s double dip speaks for itself, and mocked Cameron and former ECB head Jean-Claude Trichet for their belief in “the confidence fairy,” just to make sure we all realize just how silly the whole idea was.

Now not only was Krugman arguing that fiscal austerity in a depressed economy was bad policy because it would hurt the unemployed, he even went so far as to say it was counterproductive on its own terms. Krugman made this argument in numerous articles over the years; let me just give a flavor:

In July 2010, in a post titled “Self-defeating Austerity,” Krugman spelled out the logic quite clearly:

There’s a quite good case to be made that austerity in the face of a depressed economy is, literally, a false economy — that it actually makes long-run budget problems worse.

Suppose you slash spending equal to 1 percent of GDP. That looks like a budget saving, right? But if you do it in the face of an economy up against the zero bound…it’s going to shrink the economy…

Now, a weaker economy means less revenue…[Further,] the government has to borrow those funds [that otherwise would have been spent]; let’s say the real interest rate is 3 percent…Then the long run impact of the austerity on the fiscal position is to reduce real interest payments by 0.0195 percent of GDP.

But wait: what if there are long-run negative effects of a deeper slump on the economy? [Krugman then lists a bunch.—RPM] And so on. And here’s the thing: if the economy is weaker in the long run, this means less revenue, which offsets any savings from the initial austerity. …

In short, there’s a very good case to be made that austerity now isn’t just a bad idea because of its impact on the economy and the unemployed; it may well fail even at the task of helping the budget balance. [Bold added.]

In March 2013, after the results of (alleged) European austerity were in, Krugman reminded us that the pro-austerity folks didn’t even manage to help their budget situations, while they wrecked poor people’s lives:

Suppose that a government imposes fiscal austerity in a realistic fashion, with spending cuts getting steadily deeper relative to baseline over a period of several years. If the negative impact of these cuts is fairly large—which all the evidence coming in suggests is the case under current liquidity-trap conditions—and if the country starts from a fairly high level of debt…something alarming is likely to happen. Instead of falling, the ratio of debt to GDP is likely to rise for years. [Bold added.]

Krugman then makes up a hypothetical country called “Osbornia”—an obvious reference to pro-austerity British Chancellor of the Exchequer George Osborne—and showed how this country would actually push up its debt/GDP ratio if it foolishly tried to rein in deficits, and after a handful of years would finally claw its way back to the same debt position it would have had, had the country engaged in no austerity whatsoever. Krugman ended the article with, “Sound like someone you know?” reminding his readers that this outrageous outcome is exactly what was unfolding in the UK.

Just to make sure American readers didn’t think the problem of destructive austerity was contained to Europe, in April 2013 Krugman warned that “the truth is that [US] federal stimulus is years behind us, while state and local governments have cut back, so the overall story is one of fiscal contraction that’s smaller than in Europe, but not by that much.” Krugman then comes up with a metric (involving total government spending as a share of “potential GDP”) according to which government spending in 2013 is “significantly lower than it was under Reagan.” Krugman naturally says this is “very bad policy” given our current slump.

Now I’ve spent a lot of time documenting Krugman’s strong views just to make sure the reader trusts me when I say the following: Following the “sequester of fools” (Krugman’s term in February 2013 for the recent US budget cuts)—which Krugman warned would “probably cost…700,000 jobs”—been followed by a severe slowdown in the economy, and this bleak change led to a stunning pessimistic adjustment in the US budget situation, it is crystal clear that Krugman would have gotten dizzy from running victory laps. He would have said that this is exactly what happened in Europe, just like Krugman had been clearly warning since at least 2010: Not only is cutting spending in the face of a depressed economy bad for employment and GDP growth, it doesn’t even help your debt situation.

So what happened instead? Well, the data so far suggest the exact opposite. Rather than the big job losses from the US sequester, Reuters is reporting that US job market gains are making the Fed consider ending QE3 early. The official unemployment ratecontinues to fall steadily; you thus far don’t see any spike upward, as happened in Europe after its alleged austerity disaster. The BEA’s advance estimate for first-quarter GDP growth in 2013 is 2.5 percent, which is as high as it’s been in six of the last eight quarters. Finally, the CBO just came out with its May budget outlook, and guess what? Compared to its February outlook (i.e. just a few months earlier), the CBO’s estimate for the deficit for this year has been revised down by more than $200 billion. In FY2018—five years after this recent sequester “foolishness” has been implemented—the CBO now projects a debt/GDP ratio that is more than two percentage points lower (70.8% versus 73.1%), compared to its forecast from just a few months ago.

In short, the exact opposite of what Krugman’s writings would have suggested, has thus far occurred. So how could Krugman handle this? If he were a true gent, he might say, “Huh, that new CBO forecast, coupled with the better than expected jobs reports, is causing me to rethink just how bad US austerity is. Let’s try to figure out why it was so awful in Europe but not here.”

Or, Krugman could have said, “Well, let’s just give it another six months. I betcha the CBO suddenly realizes it made a horrible mistake, that austerity is indeed self-defeating, and we’ll see unemployment spike as the sequester destroys 700,000 jobs, at least.”

Or, Krugman could plausibly have said, “Even though I always used to rely on official government numbers, like the unemployment from the BLS and GDP growth from the BEA, now I see why the conspiracy theorists always pooh pooh them. I can’t believe the government was able to slash its short-term debt so much, without wrecking the economy; something is fishy with these numbers.”

Finally, it would have been okay if Krugman just kept his mouth shut, and hope nobody brought up the fact that the US situation (at least thus far) is the exact opposite of how he framed  the outcome of “austerity” in Europe.

Yet none of the above happened, of course. Even though the pro-austerity folks have a prima facie victory—according to the very criteria that Krugman has been using for the last several years—Krugman handled the recent CBO announcement by saying it yet again proved him right. Specifically, Krugman wrote on May 15: “The new CBO numbers are out, and they scream ‘debt crisis? What debt crisis?’” He goes on to clam:

[O]ur policy discourse has been dominated for years by what turns out to be a false alarm. To the millions of Americans who are out of work and may never get another job thanks to premature fiscal austerity, the VSPs would like to say, “oopsies!”

So there you have it folks: When European “austerity” leads to a rising unemployment, a double dip in GDP, and a collapsing budget situation, Krugman says he told us so; austerity is stupid. And when US “austerity” leads to falling unemployment, relatively strong GDP growth, and a vastly improved budget situation, Krugman says he told us so; austerity is stupid.

No wonder Krugman is so good with predictions.