Expansionary austerity is the idea that cutbacks in government spending can stimulate economic growth. Sounds weird doesn’t it, but here’s the theory as argued by Britain’s current Chancellor of the Exchequer:
Osborne insists that Britain will enjoy what he calls “expansionary austerity”, because the knowledge that the government is getting to grips with the public finances will engender confidence and encourage private spending to replace the cuts in public spending.
This theory relies on a tighter fiscal policy (tax increases and spending cuts) allowing monetary policy (interest rates and the exchange rate) to remain loose. Cheap borrowing costs lead to higher investment, while the low pound stimulates exports. This, in turn, leads to a rebalancing of the economy.
The trouble with this theory is that it’s bollocks. Paul Krugman sums up:
The Stubborn Myth of Expansionary Contraction
Mike Konczal, a fellow at the Roosevelt Institute, has been writing lately in his economics blog, Rortybomb, about American conservatives’ continuing insistence that slashing government spending is actually expansionary, as embodied in a recent report from Republicans on the Joint Economic Committee.
As he says, it’s a remarkable thing: the empirical case for expansionary austerity has collapsed on examination, but the doctrine lives on regardless.
One thing Mike fails to note is that another recent paper on deficit reduction from the American Enterprise Institute, which is cited by that J.E.C. study in a way that might make you think that it supports the case for expansionary austerity, actually never provides any evidence to that effect; … It’s notable that the J.E.C. report also blithely cites Canada and Sweden in the 1990s as demonstrations of its case, even though both have in fact been extensively debunked. …
I have to say, it’s remarkable how quickly expansionary austerity has gone from interesting speculation to zombie idea, repeatedly killed by evidence but still shambling toward us, trying to eat our brains.
So the empirical evidence (see Konczal’s work here) doesn’t support the theory. But in Britain the Tories charged ahead with it anyway, slashing spending left right and centre. How’s that working out for them?
Is Osborne fit to run the economy – or to ruin it?
George Osborne is expecting ‘expansionary austerity’ to save the UK economy – which means things are going to get a whole lot worse for ordinary households
… This government has now been in power for almost a year and here’s a check list of their achievements so far. Unemployment, going down a year ago, is now going up. Real incomes fell last year for the first time since 1981 and are on course to fall again this year. Consumer confidence has slumped to levels seen in the depths of the recession. High street retailers are sending out profit warnings. And, to cap it all, the government has been forced to revise up its forecasts for the budget deficit.
… The empirical case against expansionary austerity is that it doesn’t seem to be working in Britain (or in any of the struggling eurozone countries), whereas good old fashioned fiscal expansion does seem to be doing the trick in the US.
Despite two years when bank rate has been pegged at 0.5%, there is a marked reluctance to borrow. Mortgage demand is running at half the levels seen in the 10 years leading up to the financial crisis, and lending to businesses is not picking up.
… Where is the evidence of expansionary austerity? Not in the balance of payments figures, which are getting worse not better. Not in the high street, where consumers would need to see their incomes rise by 6% to compensate for the price increases and tax rises of the past year. And not in the business community, where investment fell in the final three months of last year.
Not so good in practice then. Keynes gets the last laugh.
Right, pop quiz time. Can anyone think of another government, not a million miles from here, that is pinning its hopes on expansionary austerity? Another government that is ignoring the theoretical counter arguments and all the empirical evidence? Another government that is run by Tory fools and getting the same results as the same policies in England? Another government that is seeing its economy flatline, growth stalled, unemployment rising, costs spiralling out of control? Anyone? Anyone?
Makes you wonder doesn’t it. Just how stupid would we be to give these failed policies another term…