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The Stupidity of Austerity in a Recession
The reason governments are in deficit is the financial collapse and the recession that followed hard upon it. (For the time, let us ignore the mammoth tax cuts for the wealthy during the Bush administration that turned surpluses into deficits.)
When people lose their jobs they pay less in taxes, including sales tax (affecting states and cities) and income tax (affecting the Federal government), and they spend less. Austerity accelerates these very processes and thus deepens the recession and further reduces tax revenues.
Can’t these people understand something so mind-bogglingly simple? Let us demand that Obama and the Democrats don’t make the same mistake that Roosevelt made in 1937, when he submitted a balanced budget and created a sharp recession.
Here’s an historical unemployment chart from the Wikipedia:
Notice the sharp spike in unemployment around 1938? That was the result of enacting a balanced budget while the nation was still in recession.
There are present grounds for concern. The commission Obama has assembled to work on the deficit is packed with conservative dinosaurs known to have opposed Social Security and who would like nothing better than to eliminate the deficit on the backs of the most vulnerable of the American people. Exhibit A: former congressman Alan Simpson, an extreme rightist, is the Republican co-chairman of the commission.
Economist Robert Kuttner has issued serious warnings about austerity in times of recession:
The current global economic crisis, now entering a new phase as a crisis of sovereign debt, has only one rough precedent. The last time major nations (such as Germany, its European creditors, and much of Latin America) faced insolvency, the combination of financial collapse and deflation helped create depression, dictatorship, and then World War II.
In the US, we finally ended the Great Depression with massive wartime borrowing and public outlay. We ended the war with a debt-to-GDP ratio of more than 120 percent, more than double today's ratio. In Britain, debt-to-GDP peaked at about 250 percent.
He points out the difference this time, however:
Today’s situation is different. The origin of all the debt is not a war but a financial collapse. The new round of financial panic is the result of still fearful markets, a still fragile banking system, and deficits caused mainly by reduced output, not overspending.
In this context, it is insane to think that we can recover from a financial panic and an economic recession by inducing a worse recession in the name of fiscal soundness. For now, while the real economy heals, there is no substitute for aggressive central bank intervention to restore markets in sovereign debt. The right grand bargain is tough financial reform and limits on Wall Street--so that this crisis is never repeated. The wrong grand bargain is austerity for everyone else.
I was always under the impression that this was Economics 101, but obviously, the deficit hawks took a different class—one that required them to completely forget history and abjure common sense.
Obama is no fool, and he undoubtedly knows all this. Is the commission merely window-dressing, so that Obama can say that he attempted to be bipartisan but was thwarted at every turn by the Republicans? Or is it simply a means of delay, so that the stimulus can lower unemployment and lower the deficit by election time in November and nothing more needs to be done? That’s a risky game.
The stimulus was almost certainly inadequate and Congress is reluctant to enact another one any time soon. Obama will be stuck with whatever happens. For all our sakes, l hope he succeeds.