Wednesday, 26 February 2014

PS on Germany

'The myth of German austerity' is the title of a recent post on Paul Krugman's blog. He's making an important point about public spending: Germans were far less austere than most other European nations. In this sense the German case confirms what critics of austerity have argued all along: less public spending cuts=higher growth.

However, it needs to be added that Germans experienced substantial economic harshness ('austerity') because of stagnating real wages.

But neither the fake austerity in public spending nor the real abstinence of wage earners are at the root of Germany's slightly better economic performance. This is caused by significant export surpluses which are problematic for a number of reasons outlined in previous posts.

Monday, 17 February 2014

No cash, no party

Still working on the German foreword (among other stuff). Here is another objection to austerity critique that you get frequently in German debates: 'why all the fuss about austerity? It's simple really: if you don't have money you cannot spend any.'

This is based on the experience of private households and sounds like common sense. However, if you think about it a bit more it is a rather silly idea. Even for private households this principle only makes sense in part and it is completely wrong when you think about businesses and states.

True, private individuals need to tailor their expenditure to their income. But even private households are not normally expected to have 'balanced books' at all times. For example, it is common that young families go into debt to buy a home and then pay off the mortgage over time. It would not make much sense to allow families to buy homes only once they can pay in cash. If families were prevented from taking out loans most would be able to buy a family home when they do not need it anymore.

Renouncing credit makes even less sense in the cases of businesses. They need to invest when an opportunity presents itself. Even if they do not have the necessary funds at the time. Without credit the 'economic miracle' by which capitalism has multiplied the wealth and prosperity of many nations over the last centuries would have been impossible.

And states? In contrast to private households their level of income depends to a substantial extent on their level of expenditure. If states spend less, employment and investment likely decline and this leads to reduced tax income. This is what sets state a part from private individuals. If the later spend less this will not bring down their income. They will simply accumulate more savings. But because of feedback loops the state's income tends to decline with its spending. There is some debate about the extent that GDP declines for every Euro that governments cut. Nonetheless, there is overwhelming evidence that this link exists. (See here and here.)

Therefore it makes a lot of sense for states to behave anti-cyclically: cut expenditure during the boom and expand it during economic downturns. What matters is that government finances are balanced in the medium and long term. In the short term it often makes sense to spend money that you do not have. 

Wednesday, 12 February 2014

Austerity. The great failure.

Is out now. Details here.

More notes for preface of German edition

Another objection to austerity critique often heard in Germany and elsewhere is this: the reason austerity appears not be working is that we haven't really tried it yet. Proof? Well, the central banks are printing money like mad. How can this be austerity?

This is an odd argument because it connects different things that are not directly related. Yes, some central bank are 'printing money'. They are engaging in 'quantitative easing' which consists in buying financial assets from banks and other institutions. This provides these institutions with liquidity and props up demand for financial assets. 

How does this relate to austerity? There is no fixed definition of what austerity means. Some people use it to mean cuts of public expenditure. This is close enough to what is happening but in the book I defined austerity more broadly as abstinence from consumption. That comprises most of today's cuts to government expenditure. That's because most government expenditure is for forms consumption anyway and government expenditure for investments is often not reduced as much.

In theory, governments could (and should) take advantage of the liquidity injected by central banks and the low interest rates in order to finance stimulus programs (building roads, power lines, schools or hire more teachers, pay firefighters more etc etc).  But because governments are committed to austerity policies they won't. Companies could take advantage of easy finance--to the extent that it trickles down to small and medium businesses--and invest. But they won't because there is no market for additional output. Private individuals could also take out loans and consume. But they won't because of economic uncertainty and because many people just got burned during the last round of easy credit. 

So there is not really much impact of these monetary measures on demand and hence on investment and growth. That's unfortunate because economies urgently need stimulus to kick-start growth. But in current conditions additional liquidity will not do the trick because no one is willing to spend it. Additional demand needs to be created directly through government expenditure (in the short term) and income redistribution (in the medium term)

The only sector where demand may actually be stimulated by the current monetary policy are financial markets. Cheap money is used for financial speculation: despite the depressed economic situation stock exchanges are up. The supply of liquidity may well result in new asset bubbles on the financial markets but it does very little to alleviate the problem of depressed consumption and investments.

Quantitative easing is not the antidote to austerity. It's an attempt of central banks to do something to keep economies going while austerity politicians are doing their best to strangle growth.