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. 

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