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AUSTERITY: Failed Economics but Persistent Policy / Vol. 80, No. 3 (Fall 2013)

Teresa Ghilarducci and Rick McGahey, Guest Editors
Arien Mack, Journal Editor

This issue features the discussion of economists on the limits and failures of economic analyses supporting austerity policies, showing how these policies hold back economic growth and analyzing why they persist in spite of their poor track record.

Arien Mack pays tribute to John Hollander—a remarkable poet, scholar, teacher, and good friend.

David Bromwich writes in memory of poet, teacher, and critic John Hollander.

Five years after the 2008 worldwide financial crisis and the resulting Great Recession, most of the global economy is still stagnating. In response to the economic downturn, many nations experimented with austerity, which constricted public spending and investment in the name of boosting business confidence.


The history of market systems reveals recurrent patterns of booms and busts over centuries, emanating precisely from the developed world. Economic historians speak of the Depressions of the 1840s, 1870s, and 1930s, and of the Great Stagflation of the 1970s, and course the current one which is the first Great Depression of the 21st century. The present crisis has exposed the weaknesses of orthodox economic theory which is built upon an idealized and utterly fictitious vision of capitalism characterized by optimal production and consumption outcomes and the automatic full employment of labor. This paradigm was utterly unable to recognize the build-up to the current crisis, and has failed to develop models relevant to our current circumstance. Alternative viewpoints, such as the one in this paper, have been almost entirely excluded from the conventional discourse. We need to open up a space for a more vigorous debate among competing views.

This paper reviews the intellectual basis of austerity macroeconomics. We show that mainstream macroeconomics, because of its insistence on viewing the macroeconomy through the lens of general equilibrium methods, entails an analytical precommitment to austerity policy. This leaves economists who work within this framework without a robust basis for developing models and arguments that contest austerity policies. And since this approach has been the dominant framework in macroeconomic theory for the past three decades, professional opinion has not moved. New approaches which model the macroeconomy as exhibiting disequilibrium dynamics and being prone to instability are needed.

The issue of economic austerity has been more debated today than at any time since the 1930s. Austerity policies have had longstanding support from economists, beginning with the writings of Hume, Smith, and Ricardo in the eighteenth and early nineteenth centuries, providing both microeconomic and macroeconomic justification for minimal state intervention and public debt creation. Given this long tradition, we might ask why the debate around austerity has not been satisfactorily resolved. I argue below that the fact that the debate is ongoing does not reflect a lack of theoretical effort. Debates over economic austerity go beyond the standard guideposts of scientific disagreement and reach down to conceptions of economic life, economic morality, and economic well-being. Social science cannot resolve disagreement at this level.


In the face of failed economic performance and intellectual disarray, it is surprising that austerity continues to have such an influence on economic thinking and policies. This article traces the history of austerity policies in the United States, seeking to account for the power that such ideas continue to have. Austerity policies are slowing the economy and preventing necessary public investments that can help support future economic growth. Understanding the continuing power of these ideas and policies is one part of creating a better informed policy debate, and advocating for policies that can help restore economic growth and promote social equality.

Amid the wreckage of the 2008-09 Wall Street collapse and Great Recession, orthodox economists and political elites in both the United States and Western Europe have been strongly pushing the idea that austerity is the only viable policy option. Are the austerity hawks correct that there is simply no alternative to their agenda? In fact, the austerity hawks’ arguments are wrong across the board. Focusing on the U.S. case, this paper shows that the austerity hawks claims about large deficits causing high inflation and interest rates have been consistently wrong for four years. Moreover, U.S. is nowhere near experiencing a fiscal crisis in the commonsense definition of the term, which is to say, the government is facing difficulties in meeting its commitments to creditors.

Our article discusses the formation of a National Investment Employment Corps as a direct alternative to austerity economics. Given the disproportionate effect of the “Great Recession” on African Americans and Latinos, the federal government’s attempt to stimulate the private sector while Congress cuts essential public services and safety nets only begs for disastrous consequences akin to current crises in Europe and throughout the globe, while worsening conditions for aforementioned and other unprivileged groups. Instead, we propose investing in a National Investment Employment Corps to provide a job guarantee for all citizens with the purpose of maintaining and expanding the nation’s physical and human infrastructure. A National Investment Employment Corps program would not only address employment needs for blacks and Latinos, but also serve as a solution over fiscal austerity by providing full-employment while simultaneously ensuring long-term benefits toward the national well-being.

This essay begins by establishing that US income inequality was high relative to other high-income countries in 1980 and became an extreme outlier by the mid-2000s. It then provides a brief account of the main forces underlying America’s path to extreme inequality and low wages. Finally, it shows how low-paid workers in the United States have fared relative to their counterparts in the rest of the rich world. It does so by reference to two sets of findings from my recent research. The first finding is that extreme inequality has not only not bought the United States exceptional productivity growth, but also that the United States shares less of its productivity growth with wage earners than is typical of other rich countries. The second set of statistics shows that the US low-wage share of employment is the highest in the rich world, and reports that the share of young, less-educated workers paid low wages is far higher in the United States than France, mainly due to the diametrically opposed minimum wage policies. At the same time, the evidence does not support the orthodox prediction that French employment performance worsened for these workers, either in absolute terms or relative to their US counterparts. The widespread advocacy for austerity in the current political debate is a reflection of the power of the same free market fundamentalism that generated and promoted the post-1980 laissez-faire experiment. To reduce inequality and promote economic growth and middle-class incomes, the article concludes with a call for replacing this disastrous experiment—including its prescriptions for austerity for the less well-off—with a return to the relative egalitarianism of the pre-1980 era.


From paragraph--In what follows, we will shed some light on meaning of empirical estimiates of the multiplier an their proper use. On the general level, we will undertake a critique of the multiplier, explaining the role that various assumptions play in the three leading methodologies for calculating multiplier values. We find that two types of assumptions are crucial: “counterfactual assumptions” that specify the baseline against which the impact of the stimulus is judged and “behavioral assumptions” about the decision-making processes of economic agents. On the specific level, we apply what we learn from the critique to a sample of recent work claiming that certain aspects of the 2009 American Recovery and Reinvestment Act’s (ARRA) stimulus were ineffective—in particular, work by Stanford’s John Cogan and John Taylor claiming that ARRA funds funneled through state governments had no effect because states saved rather than spent the funds. We argue that the conclusions of these studies are highly sensitive to counterfactual and behavioral assumptions that are in some cases questionable and in others clearly implausible. We conclude with some general thoughts on the proper use and interpretation of the multiplier in assessing fiscal stimulus programs.

The main purpose of this study is to analyze the macroeconomic dynamics and stability of an artificial monetary union consisting of two industrialized economies with the similar economic structure (for the sake of concreteness, Germany and France) under a stylized debt brake rule using an estimated semi-structural dynamic macroeconomic model. The rationales for fiscal budgetary rules are briefly discussed and the functioning of a particular type of budgetary rule–the German debt-brake–is explained in detail. In this context, the two main pitfalls of such a rule are discussed: the accurate estimation of potential output and the international dimension of the implementation of such a rule in the context of the euro area. Next, a stylized two-country macroeconomic model of a monetary union along the lines of Flaschel et al. (2008) and Proaño (2009) is discussed and implemented for the evaluation in terms of macroeconomic stabilization of a stylized debt rule under the assumption that the fiscal authorities do not directly observe the actual output gap of the economy.

This paper argues that policymakers wildly underestimated the negative effects of austerity because the fiscal multiplier’s effect is asymmetric - - larger in recessions and weaker in expansions, meaning that government spending increases can stimulate the economy in a recession, but also that spending cuts and financial market stress can make the effects of contractionary policies even more severe than a simple view of multipliers would suggest. Austerity in the form of government spending cuts, output, and income causes unemployment to increase, tax revenues to fall, and sovereign deficits and debt to rise, triggering more financial stress, and so on in a downward spiral. Instead of simply downsizing government spending, the entire economy shrinks as a result of government spending cuts. If governments respond to economic decline with further spending cuts, the negative spiral accelerates.


This article focuses narrowly on three critical economic issues and their relationship to democratic transitions: economic crisis, economic growth and the middle class, and public expectations for social and economic opportunities. History provides compelling insights. First, short-term economic crises are often the proximate trigger of regime change. Second, economic growth under autocracy does not lead to political freedom, but the robust middle class that generally emerges as countries become more prosperous can prevent backsliding to authoritarianism once democracy is established. Third, the promise of political freedoms raises people’s expectations for material opportunities, so failure to deliver on these expectations makes a return to authoritarianism more likely.

One of the most surprising realities of the past four years of the global economic crisis has been the strong performance of many Latin American countries—in many cases exceeding the growth of the United States and Europe. The experiences of Latin American economies with austerity is described by declining performance followed by a decade of experimentation and increasing awareness and confidence about the role of national economic policies in managing crises and shielding national economies from global volatility. Record-level growth was interrupted by the effects of the global financial crisis after the collapse of Lehman Brothers in October 2008. The effects of the global economic crisis on the region led to the explicit decision by most Latin American governments not to follow austerity policies in order to sustain growth. This decision has largely been successful, although sound fiscal performance has been affected by monetary pressures that appreciated Latin American currencies. Latin American experience of more than 60 years strongly suggests that policies restricting spending can have major negative impacts on national economic growth and social welfare. Those promoting spending, on the other hand, have a greater likelihood of maintaining aggregate demand at the macroeconomic level while providing key services and infrastructure needed for minimal levels of well-being.

Austerity political economy is a platform for justifying cuts in the social wage. Raising the social wage raises nonlabor income, living standards for working families, and makes retirement—and other forms of paid nonwork—possible. A higher social wage increases the relative bargaining power of workers in the labor market. It is not a surprise that advocates for cutting social spending expenditures attempt to divide the interests and political strength of working families. A particular form of the division is the false claim that spending for the old takes away from spending on youth. There is no evidence for the argument that in the light of shrinking federal spending, any dollar preserved for the old will be taken away from the young. This claim is fierce and wrong.


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