Cut or loose History suggests that austerity and growth just do not mix

[xchrom]

http://www.economist.com/node/18956566

TO LISTEN to Barack Obama, there is no trade-off between supporting a weak economy and tackling America’s strained public finances. “We have to cut the spending we can’t afford so we can put the economy on sounder footing,” the president said on July 2nd. Big spending cuts are necessary, he added, to “give our businesses the confidence they need to grow and create jobs”. Perhaps. A successful outcome to talks between Congress and the White House over a multi-trillion-dollar package of budget cuts is clearly preferable to a chaotic debt default. Then again, public-sector job losses helped drive the unemployment rate up to 9.2% in June, which didn’t obviously do a lot for confidence.

Mr Obama is not alone in arguing that austerity can boost growth: Britain’s deficit-slashing coalition government and the European Central Bank (ECB) also make the case. A decline in interest rates due to a lower probability of default should support investment and asset prices. Expectations of lower future taxes and higher lifetime earnings may encourage investment and spending. A new ECB working paper argues that “a fiscal contraction may turn out to be expansionary if the expectation channel becomes sufficiently strong.” In practice, however, it rarely works out that way. In a recent study of 173 fiscal-policy changes in rich countries from 1978 to 2009, economists from the IMF found that cutting a country’s budget deficit by 1% of GDP typically reduces real output by about two-thirds of a percentage point and raises the unemployment rate by one-third of a percentage point.

Occasionally, an economy will buck the trend. In a new paper, Roberto Perotti of Bocconi University presents a series of case studies of “expansionary austerity”, in which cuts in spending coincide with GDP growth. Support for the confidence theory is scarce. In only one of the cases considered—a period of Danish fiscal consolidation from 1983 to 1986—did rising domestic demand lead an expansion. And Denmark in 1983 could scarcely be more different from America today. Its economy was stronger, growing at 4% per year when austerity began (compared with 1.9% in the first quarter for America). More important, Denmark had stratospheric interest rates. Consolidation succeeded in bringing long-term rates down from a peak of 23%. Durable-goods consumption and investment boomed. House prices rose by 60% from 1982 to 1986, raising household wealth and buoying confidence. In America the long-term interest rate is already on the floor, at under 4%, yet consumption remains anaemic. Housing markets are stuck in a post-crash funk. With interest rates low, an austerity-induced fall in inflation would increase real rates and weaken an already listless economy.

[Taverner]

1. See: History of Israel, 1948-58

Austerity worsened their problems

[daa]

2. Between Borders and Cisco 20,000 people are getting fired

Does he really think that cutting their help will get him the votes of those fired and their families?? Carville taught us its the economy stupid and there are some really stupid people in
DC.

[Fearless]

3. +1