Confronting the Austerity AgendaPosted: October 28, 2011
Paul Krugman takes on the idea that after we bail out economically destructive banks, we all have to pay with downsized lives and a bad economy in his NYT column today. He continues to fight the idea that austerity–not prosperity–will bring back confidence and the economy. He’s right that the austerity hawks push a ridiculous assertion that denies past history as well as logic.
The doctrine in question amounts to the assertion that, in the aftermath of a financial crisis, banks must be bailed out but the general public must pay the price. So a crisis brought on by deregulation becomes a reason to move even further to the right; a time of mass unemployment, instead of spurring public efforts to create jobs, becomes an era of austerity, in which government spending and social programs are slashed.
This doctrine was sold both with claims that there was no alternative — that both bailouts and spending cuts were necessary to satisfy financial markets — and with claims that fiscal austerity would actually create jobs. The idea was that spending cuts would make consumers and businesses more confident. And this confidence would supposedly stimulate private spending, more than offsetting the depressing effects of government cutbacks.
Some economists weren’t convinced. One caustic critic referred to claims about the expansionary effects of austerity as amounting to belief in the “confidence fairy.” O.K., that was me.
But the doctrine has, nonetheless, been extremely influential. Expansionary austerity, in particular, has been championed both by Republicans in Congress and by the European Central Bank, which last year urged all European governments — not just those in fiscal distress — to engage in “fiscal consolidation.”
And when David Cameron became Britain’s prime minster last year, he immediately embarked on a program of spending cuts in the belief that this would actually boost the economy — a decision that was greeted with fawning praise by many American pundits.
Now, however, the results are in, and the picture isn’t pretty
Example one: The economy of Greece. It has been pushed into an even bigger slump. Example two: The economy of the UK. Austerity has stalled its economy and the confidence fairy is no where to be seen. Example three: Iceland. They did the exact opposite and they’re none the worse for wear. So, which example are we following? Well, it’s not Iceland.
Krugman, Icelanders, and the IMF are taking stock of the Iceland experience this week in a conference. You can read many articles at the IMF on how Iceland is recovering from its 2008 economic catastrophe. You can watch a video explaining what went on there with Dr. Joseph Stiglitz below.
Today, three years later, it is worth reflecting on how far Iceland―a country of just 320,000 people―has come since those dark days back in 2008. Growth has returned to the economy, and new jobs are being created: unemployment, although still unacceptably high for a country used to near-full employment, has dropped below 7 percent of the work force. In June this year, the government successfully issued a $1 billion sovereign bond, marking a return to international financial markets.
And while public debt, currently at around 100 percent of GDP, is much higher than before the crisis, an impressive consolidation program has put the country’s finances back on a sustainable path during the past couple of years. As for the banks, they have been shrunk to about 200 percent of GDP, and are now fully recapitalized.
So, how did they do it? Did they embrace austerity for their citizens after rescuing and enriching their errant banking/financier class?
- First, a team of lawyers was put to work to ensure that losses in the banks were not absorbed by the public sector. In the end, the public sector did of course have to step in and ensure the new banks had adequate capital, but it was insulated from vast private sector losses. This was a major achievement.
- Second, the initial focus of the program was exclusively on stabilizing the exchange rate. Here, we reached for unconventional measures, notably capital controls.
- Third, automatic stabilizers were allowed to operate in full during the first year of the program—effectively delaying fiscal adjustment. This helped support the economy at a time of severe strain.
- Fourth, conditionality was streamlined and focused on the key issue at hand—rebuilding the financial sector. While there are some issues in the broader economy where reforms will eventually be needed, these were not a part of the program.