Tuesday, April 24, 2012

People Are Finally Figuring Out: Austerity is Stupid

From the Financial Times:
“We can only win back confidence if we bring down excessive deficits and boost competitiveness,” he said. “In a such a situation, consolidation might inspire confidence and actually help the economy to grow.”
The above statement shows why austerity is simply one of the dumbest policies on the planet.  First, The EU region was already growing at a slow rate when people started to talk about austerity.  Consider the following chart:

Since the end of the recession, the best seasonally adjusted annual rate of growth (SAAR) is 2.4%.  But that figure is really an outlier; looking at the chart we see that the rate of growth can be broken down into two time periods.  The first -- the five quarters coming out of the recession -- growth was actually OK; it averaged 1.78% while the median number was 2%.  But since then -- when the continent decided to implement austerity -- the growth rate slowed.  Either way, growth was not strong enough for the economy to achieve "escape velocity" -- a rate of growth that creates a self-sustaining, private sector led growth rate over 2.5%.  As a result, unemployment hasn't dropped, but instead has risen:

Coming out of the recession, we see increased unemployment -- which is to be expected, as unemployment is a lagging indicator.  However, since then unemployment hasn't dropped, indicating that the economy hasn't hit that critical growth level where employment picks up.  In fact, we see unemployment increase overall,  


So -- what was the policy response?  Cut spending in the hopes that would "inspire confidence" so that the economy would grow.  The problem with this is simple.  It completely runs counter to what is needed -- spending.  Again, consider the GDP equation


Consumer spending and investment drop in a recession and in the quarters coming out of a recession.  Exports help, but they're not the predominant component of GDP.  That leaves government spending to pick-up the slack.  And there is plenty of room to do this.  Consider the following chart of the EU debt/GDP level:

It currently stands at 85% -- hardly crisis levels.

And we haven't even mentioned the worst part yet: the overall economy is now probably in a second recession, largely caused by slowing demand, caused by (drum roll please) austerity!  And, worst of all, the economy may be entering a negative feedback loop: low demand leads to more unemployment which leads to lower demand ... you get the idea.  

As for the whole "confidence will return" argument: businesses don't invest in slow-growth environments when there is obviously slack demand.  Put another way, ask yourself this question: would you rather sell your product into a market that has 2% SAAR or 3.5% SAAR? 

Also consider this from the NY Times:
With political allies weakened or ousted, Chancellor Angela Merkel’s seat at the head of the European table has become much less comfortable, as a reckoning with Germany’s insistence on lock-step austerity appears to have begun.

“The formula is not working, and everyone is now talking about whether austerity is the only solution,” said Jordi Vaquer i Fanés, a political scientist and director of the Barcelona Center for International Affairs in Spain. “Does this mean that Merkel has lost completely? No. But it does mean that the very nature of the debate about the euro-zone crisis is changing.”

A German-inspired austerity regimen agreed to just last month as the long-term solution to Europe’s sovereign debt crisis has come under increasing strain from the growing pressures of slowing economies, gyrating financial markets and a series of electoral setbacks.

Spain officially slipped back into recession for the second time in three years on Monday, after following the German remedy of deep retrenchment in public outlays, joining Italy, Belgium, the Netherlands and the Czech Republic. In the Netherlands, Prime Minister Mark Rutte handed his resignation to Queen Beatrix on Monday after his government failed to pass new austerity measures over the weekend.

The political upheaval drove stock markets on the Continent sharply lower, with Germany’s DAX index finishing the day down 3.4 percent. The sell-off in Europe dragged American indexes down around 1 percent. A survey of European purchasing managers showed an unexpected plunge in confidence this month.

The Netherlands, a staunch supporter of the German position, became the latest European country forced into early elections by the European crisis, just one day after the first round of presidential voting in France raised the possibility that the incumbent, Nicolas Sarkozy, would be unseated by his Socialist challenger, François Hollande, in a runoff election.

 From trading floors to polling stations to the streets of cities across Europe, the message appears increasingly to be that countries cannot cut their way to fiscal health. They need growth, too. In recent months, powerful voices have joined the chorus, including those of the managing director of the International Monetary Fund, Christine Lagarde, and Italy’s prime minister, Mario Monti. Treasury Secretary Timothy F. Geithner has called repeatedly for Europe to defer budget cutting in favor of some form of stimulus spending

OK, so people have put their hand on the stove, turned the heat on an learned that its hot.  Wow -- hardly a new concept to people who read this blog, but obviously to people who haven't learned a damn thing from history.  Anyway, it's good to see sentiment changing, but we're still not out of the woods.

See also this post at Brad DeLong, which links to Professor Krugman.

To get an idea of what they should be doing, please read this primer on Keynesian policies.