Home
I'm fascinated that there's still a debate on the question of whether the best way to help the economy in the long run is by higher taxes on the rich plus government stimulus versus austerity and lower taxes. You would think that with so many governments around the world trying one policy or the other for the past hundred years we would have an unambiguous track record to inform us. One of those approaches - stimulus versus austerity - must be better than the other, right?

Instead of clarity, I see proponents of government spending and higher taxes cite the Clinton administration as a time when higher tax rates coincided with a booming economy and a more balanced budget. Proponents of austerity point to Estonia's recent success in belt-tightening. Where's my clarity, damn it?

I declare a link war!
In the comments, give me links to support one argument or the other with historical examples. Keep your comments brief, please, with just a summary of the link. I'll compile them and declare a winner.

My bias going into this is that the best approach to stimulus versus austerity depends on whatever else is happening in the economy. If you have a dotcom boom happening, you can probably raise taxes with impunity and balance the budget too. If not, perhaps the austerity thing makes more sense. That's my starting point. I'd like you to change my mind.

Link on!

[Update: This link will be hard to beat. Thanks to Kuvuplan for that.]


 
Rank Up Rank Down Votes:  +40
  • Print
  • Share

Comments

Sort By:
+4 Rank Up Rank Down
Sep 13, 2012
I can't beat the link you posted from Kuvuplan, that was good.

The most obvious situation I can provide is how most countries got out of the Great Depression because of the spending on WWII. Except for Japan which got out of the depression early with stimulus/military spending.
http://en.wikipedia.org/wiki/Great_Depression

In the World War II and Recovery section: ... "In the U.S., massive war spending doubled economic growth rates, either masking the effects of the Depression or essentially ending the Depression. Businessmen ignored the mounting national debt and heavy new taxes, redoubling their efforts for greater output to take advantage of generous government contracts."

In the Japan section no mention of tax rates but supports the stimulus concept:
... "By 1933, Japan was already out of the depression. By 1934, Takahashi realized that the economy was in danger of overheating, and to avoid inflation, moved to reduce the deficit spending that went towards armaments and munitions.
This resulted in a strong and swift negative reaction from nationalists, especially those in the army, culminating in his assassination..."

 
 
+2 Rank Up Rank Down
Sep 13, 2012
>You are quite right that we should make every effort to learn lessons from history, but we should pick the economic period that most closely matches our own. The "stagflation" period of the 1970s was indeed a time where a conventional Keynesian approach appeared to break down, but the fact is the economic problems of the 1970s are almost as different from the problems of today as it is possible to be.

This is incorrect. Just as in the 1970's we're facing massive resource shortages. The commodities like oil are spiking just as they were in the late 70's:

http://www.wtrg.com/prices.htm

So just as in the late 70's a keynesian response is likely to lead to stagflation.

I'd also point out that Krugman and Delong treat "GDP" as if it is one, homogenous mass of goodness, and every job added as being positive. IN reality, the jobs added are just welfare with a shovel. It would make more sense to pay people not to starve and save up as much money as possible while the economy shrinks back to its real productive size. Also, if you increase government spending, you increase GDP, but that additional GDP increase isn't necessarily based on an increase in wants being satisfied, but simply in activity for the sake of activity. Keeping GDP up isn't the be all to end all, and pumping up GDP with stimulus simply kicks the can down the road further. After all, we responded to the dot com crash with years of below zero real interest rates and federal/state deficits, and all it did was jack up commodity prices while leading us into the current recession.

So yes, Krugman etc are TECHNICALLY correct in that jobs numbers and GDP will improve with stimulus, but they ignore that the economy improves simply because more debt is pushed into the system, and the US is lucky enough to have the world reserve currency, which is itself propped up by military and political power around the globe. The only way for the real productive economy to recover is for the debt to be taken of the table, which will indeed lead to a period of stagnation, but how much more debt can we inject into the system before it is simply too late?
 
 
+3 Rank Up Rank Down
Sep 13, 2012
@dongeddis

I do indeed identify normal monetary policy with setting the interest rate because that's what normal monetary policy is. It would be a strange definition of 'normal' that includes NGDP targeting, which has never been the stated policy of any central bank.

But hey, I'm all in favour of unconventional monetary policy. And as we're in a link war, I might as well point out that so are Krugman and DeLong. In fact, the very site you linked to lists them as proponents:

http://www.ngdp.info/nominal-GDP-level-target-proponents.aspx

Here's the link where Krugman explicitly supports NGDP targeting:

http://krugman.blogs.nytimes.com/2011/10/19/getting-nominal

And if you read his work on Japan you'll see that he's long been in favour of trying unconventional monetary policy.

It's not an either/or of course (unless you're ideologically opposed to fiscal stimulus). It's conceivable that both unconventional monetary policy and fiscal expansion could generate the required increase in demand, although the former has yet to be proven in practice. In fact, about the only unconventional policy that's been tried is QE, and it's not exactly been a roaring success in either Japan or the US.

The correct mix of methods may simply be what is politically feasible, as Krugman points out here:

http://krugman.blogs.nytimes.com/2011/06/20/woodford-on-monetary-and-fiscal-policy/

(Though note the two arguments why fiscal stimulus may be the more feasible option in general)
 
 
Sep 13, 2012
blah... continual downward trend since January, 2008... Had to type the damn thing twice, because I got logged out.
 
 
Sep 13, 2012
Weird... looking at the Federal Bureau of Labor Statistics employment numbers (http://www.bls.gov/webapps/legacy/cpsatab1.htm)

October, 2009
Employed Americans: 58.7% (as percentage of working-age Americans)
Unemployed Americans: 9.8% (as percentage of working-age Americans)

August, 2012
Employed Americans: 58.3%
Unemployed Americans: 8.1%

How do BOTH numbers go down?! Looking at actual EMPLOYMENT numbers, it's clear that there's nothing resembling an economic recovery. Employed Americans have been on a continual downward trend since January, 2012 (62.9% Employed) where it was within a few tenths of a percentage point of what it had been since January, 2002 the earliest date I can pull data.
 
 
Sep 13, 2012
@Therion

Please be clear in what you're arguing for dude. Several comments ago you were advocating taxing domestic bondholders. Period. Now you're talking about taxing the rich. My arguments were directed against the tactic of taxing domestic bondholders.
 
 
Sep 13, 2012
@Greensk: You and Krugman are right, that (the fall in) aggregate demand matters, and that, as you say, "it would be a simple matter to use monetary policy to stimulate the required demand to pull out of recession".

You and Krugman are wrong that "we're stuck in a [liquidity] trap where normal monetary policy doesn't work". Because you have identified "normal monetary policy" with the simple tool of "setting the interest rate". (Maybe you're going to try to weasel with "normal" monetary policy, but then the question is: why did you never consider "not normal" monetary policy?)

That's a pathetically impoverished version of what monetary policy is capable of. Take a look at the Market Monetarists and NGDP Level Targeting:
http://www.ngdp.info/

At least Krugman recognizes the importance of aggregate demand. Unfortunately, he abandoned monetary policy far, far, far too quickly. Everything after "since monetary policy no longer works at the zero bound, we now have to move to the poor second choice of..." is completely irrelevant, because in fact monetary policy remains extremely powerful today.
 
 
-1 Rank Up Rank Down
Sep 13, 2012
@hankfu

You are quite right that we should make every effort to learn lessons from history, but we should pick the economic period that most closely matches our own. The "stagflation" period of the 1970s was indeed a time where a conventional Keynesian approach appeared to break down, but the fact is the economic problems of the 1970s are almost as different from the problems of today as it is possible to be. A much better comparison is to the Great Depression era, when Keynesian economics was exactly the right tool to understand what was going on (unsurprisingly as Keynes was trying to understand the Great Depression itself).

It was a massive government stimulus that finally banished the Depression, sadly taking the form of a World War. The war left the US with a huge debt overhang, which lead to the great economic collapse of the 1950s and 1960s.

Except of course that it didn't. The post-war period was a time of unparalled prosperity, and the debt was paid off through the proceeds of growth. Lesson learned.


 
 
-7 Rank Up Rank Down
Sep 13, 2012
"and what Im saying is if you impose a tax on these domestic bondholders then no more domestic lenders will choose to become domestic bondholders and, one by one, the domestic bondholders that do exist will choose to pay the tax and exit this game rather than keep giving the government more money to keep playing it."

So we take their money off them and they don't make as much profit. Is there any compelling evidence against doing this? No, there isn't. Your speculation boils down to the trickle down theory of wealth, which asserts that if you tax the rich then something bad will happen. Even though the data says that the countries with the highest tax burden (Scandinavia) are the richest with the best quality of life. Think about that: these countries have double the tax burden of the USA, and yet a better quality of life by most measures.

In any case, the rich would have to be pretty stupid to play coy enough with their money that it provokes the public into coming down on them like a 12-tonne anvil.
 
 
+11 Rank Up Rank Down
Sep 13, 2012
Tax Rates and Economic Inequality:
http://www.americanprogress.org/issues/tax-reform/report/2012/04/19/11404/the-federal-tax-code-and-income-inequality/

Income Equality tends to increase GDP:
http://www.addictinginfo.org/2011/07/12/tax-rates-and-gdp-growth/

Nice historical explanation on Surpluses and Deficits: (Use these charts with others to draw more conclusions)
http://www.davemanuel.com/history-of-deficits-and-surpluses-in-the-united-states.php

Nice view of money, and shows how inequality has changed, as well as feasibility of "Spending cuts only".
http://xkcd.com/980/

Neat visual on the whole thing:
http://visualizingeconomics.com/



Pro-Stimulus:
http://articles.philly.com/2012-07-03/news/32509117_1_austerity-stimulus-program-new-jobs

Pro-Stimulus:
http://www.dailykos.com/story/2012/06/01/1096532/-Austerity-or-stimulus-A-quick-note-about-that-jobs-report

Timing is everything, watch the cycles and know when to stimulate, and when to cut back:
http://www.voxeu.org/article/procyclicalists-fiscal-austerity-vs-stimulus
 
 
-5 Rank Up Rank Down
Sep 13, 2012
I got a net -2 thumbs down but no actual rebuttals? I guess the newer generations doesn't remember the term or the lessons learned from Stagflation. How convenient.
 
 
+3 Rank Up Rank Down
Sep 13, 2012
The clearest and most straightforward explanation I have read of why stimulus can work is "Sam, Janet, and Fiscal Policy" by Paul Krugman:

http://krugman.blogs.nytimes.com/2010/10/25/sam-janet-and-fiscal-policy/

The most important point to remember, and one that is never emphasised enough (except by people who know what they're talking about, like Krugman), is that the rules change when interest rates fall to near-zero levels. If it were possible to reduce interest rates below zero, it would be a simple matter to use monetary policy to stimulate the required demand to pull out of recession. But negative interest rates are impossible because people can always keep cash. Therefore we're stuck in a trap where normal monetary policy doesn't work: the famous "liquidity trap" of Keynesian economics.

I would go so far as to say that if you don't understand how and why the rules have changed once you hit the zero lower bound on interest rates, your opinion on economic policy is worthless.

Martin Wolf of the FT wrote an excellent piece on fiscal and monetary policy in a liquidity trap situation:

http://blogs.ft.com/martin-wolf-exchange/2012/04/17/fiscal-and-monetary-policy-in-a-liquidity-trap
http://blogs.ft.com/martin-wolf-exchange/2012/04/20/fiscal-and-monetary-policy-in-a-liquidity-trap-part-ii

(Martin Wolf's columns, by the way, are the best place to start if you want to understand why the austerity policies in the Eurozone and the UK are so misguided)

Of course, there are plenty of economists who argue that stimulus is the wrong policy and some who even deny that liquidity traps can exist despite the compelling evidence to the contrary. So how do we decide who is right? A good guide is to look at the predictions these economists have made: runaway inflation and rising interest rates on US government debt real-soon-now. Of course, nothing of this sort has happened, as Krugman and Brad de Long explain:

http://krugman.blogs.nytimes.com/2011/07/05/liquidity-trapped/
http://www.bloomberg.com/news/2011-07-05/the-sorrow-and-the-pity-of-another-liquidity-trap-brad-delong.html

The reason Krugman has been so on-the-money in this crisis is not because a Nobel prize somehow confers omniscience, but because he spent a long time before the crisis studying Japan's "lost decade", where a very similar situation arose, albeit not on the same global scale. I highly recommend Krugman's book "The Return of Depression Economics" for a more complete understanding of the very special economic situation we find ourselves in.
 
 
Sep 13, 2012
The Clinton years were actually a textbook example of austerity, as it was characterized not only by tax increases, but also by restraint in spending due to Clinton having to contend with an uncooperative Republican Congress.

Federal spending, after adjustment for inflation and population growth, remained absolutely flat from 1991 to 2002, a level of restraint that has no precedent in living memory. I made a chart illustrating this point here, using data from the Economic Report of the President:

http://distributedrepublic.net/archives/2006/04/21/chartistry

 
 
+3 Rank Up Rank Down
Sep 13, 2012

A few more from Cato:
http://www.cato.org/publications/commentary/realworld-cases-prove-spending-restraint-works

Canada, Ireland, Slovakia, New Zealand:
http://www.cato-at-liberty.org/spending-restraint-works-examples-from-around-the-world/
 
 
+2 Rank Up Rank Down
Sep 13, 2012

I think Cato is going to single-handedly win this puppy. Canada is a good place to start:

http://www.cato-at-liberty.org/canadas-spending-cuts-and-economic-growth/
 
 
Sep 13, 2012
@Therion

[Whtllnew, I already pre-empted that argument by saying we have an obligation to foreign countries and domestic private companies would be faced with a choice between giving loans and paying more taxes.]

and what Im saying is if you impose a tax on these domestic bondholders then no more domestic lenders will choose to become domestic bondholders and, one by one, the domestic bondholders that do exist will choose to pay the tax and exit this game rather than keep giving the government more money to keep playing it.
 
 
-2 Rank Up Rank Down
Sep 13, 2012
Whtllnew, I already pre-empted that argument by saying we have an obligation to foreign countries and domestic private companies would be faced with a choice between giving loans and paying more taxes.
 
 
Sep 13, 2012
Another comment without links.

The point of Keynsian Economics is not to raise spending while lowering taxes. Taxes should always remain relatively stable. It gives businesses and individuals a solid foundation on which to plan. What should change is spending. During a recession, needs are greater, so spending goes up. During good times, While the tax rate does not change, revenue goes up, and spending goes down (since fewer people need help). This should create a surplus to pay down the debt from the bad times. We have never put in place the real meaning of keynsian economics. When times are good, we cut taxes and create more debt. The whole thing with the Bush Tax cut was that we could afford it at the time since we had $250 billion in surplus. That money should have gone to retire the debt. Once the debt is retired, you can start to reduce taxes and try for balance. The whole idea behind the bush tax cut was a fraud. Add in to that the unfunded wars we've been fighting... WOW.
 
 
Sep 13, 2012
@Therion

[*Obviously* we have a duty to make good on our debt to foreign countries. But the givers of the loans are more often than not domestic private companies. Where is the evidence that the "debt" of the many to the few is anything we should be concerned about? Where is the evidence that we can't impose an "emergency tax" on bondholders every few decades, and threaten to tax them more unless they continue to be open-fisted with loans?]

That strategy will only work if you never intend to borrow money again from anyone but your current bondholders. Noone else will buy bonds from a government that holds their bondholders hostage like that. And sooner or later those bondholders will, one by one, bail out on this game. Which is fine, if unfair, if you intend someday to never borrow money again. Otherwise you're screwed.
 
 
-4 Rank Up Rank Down
Sep 13, 2012
[No one doubts you can temporarily goose GDP through massive government spending. That's obvious. The trick is doing that and reducing government debt at the same time, or even in the long run. Did anyone do both? -- Scott]

Well, the example of the Tories I gave shows that they're even failing at reducing government debt. Borrowing is up. Bad economy = more borrowing. If you really want to cut debt, the wise thing to do is invest in your economy and wait until it's strong.

But I don't understand your question. Why do you assume an abstraction like "government debt" is just as important as employment rate? Because in the long run government debt will mean low employment? Why not ask for links to back that *assumption* up? To me it seems to be nothing but a prejudice. *Obviously* we have a duty to make good on our debt to foreign countries. But the givers of the loans are more often than not domestic private companies. Where is the evidence that the "debt" of the many to the few is anything we should be concerned about? Where is the evidence that we can't impose an "emergency tax" on bondholders every few decades, and threaten to tax them more unless they continue to be open-fisted with loans?
 
 
 
Get the new Dilbert app!
Old Dilbert Blog