Tuesday, June 12, 2012

Paralysis by Analysis: Is Lack of Policy Certainty an Excuse for Austerity?

-- Posted by Neil H. Buchanan

I continue to be surprised that there is such concerted opposition to stimulus spending, given that nearly every major economy remains mired in the aftermath of the global financial crisis and the Great Recession. Over the last few weeks, I have been discussing (here on Dorf on Law, and in my columns on Verdict) some defenses of the "expansionary austerity" view, which is the counter-intuitive argument that government should pull back in the face of a weak economy. (Being counter-intuitive is not necessarily a bad thing, of course.) The Austerions, as Tom Tomorrow dubbed them, insist that the benefits of austerity are either still to come, or will never come because they believe (against both logic and evidence) that governments worldwide are not actually currently engaging in austerity measures.

Sometimes, however, one will hear a different argument: If there are experts on both sides, and they sincerely disagree about the wisdom or foolishness of Keynesian stimulus, then should we not simply accept that there is no consensus? And if there is no consensus, is it not best to do nothing, rather than risk making a mistake by spending when it might be a bad idea to spend?

This argument is frequently offered in good faith by people who seem to be saying nothing more than this: "Gosh, it's all so complicated, and smart guys can't agree, so how can we make a decision?" It is also sometimes offered as an excuse for a refusal to make difficult choices, often seen in Congressional hearings, where many questions seem to boil down to: "Please, Mr. Expert Witness, could you please take responsibility for this tough decision? I don't know what to think, and I don't want to take the heat."

Not all such statements, however, are uttered by naifs or cowards. For example, a top-flight tax policy scholar was recently called out (by another top-flight tax policy scholar) for making somethings very close to this argument. (I am not going to use names here, because my point is not to engage in finger-pointing. I am content simply to say that both sides of that dispute -- whose names are available at the link, for those who really care -- are highly sophisticated scholars at elite universities.)

The basic claim was this: Keynesian policies have uncertain effects, so we should not adopt them, for prudential reasons. Of course, the alternative policies on offer (in this case, corporate tax cuts) also have effects about which reasonable scholars can and do disagree; but that is somehow lost in the shuffle. Let us leave that aside, however, to focus simply on the question of whether "uncertainty" about the effects of Keynesian stimulus policies is reason enough not to adopt them.

As I mentioned at the end of a recent Dorf on Law post, one argument against using stimulus policies to bring the economy out of its current disastrous state is that such policies have effects on the economy that cannot be calibrated precisely in response to the exact state of the economy. It would be nice if we could "fine tune" the economy, with fiscal policy (or any other policy lever) available to quickly and immediately counteract any deviation from the ideal long-term path of the economy. For awhile after WWII, many Keynesian economists hoped that such fine tuning was possible. When it turned out that it was not that simple, however, the rejection of fine tuning was misinterpreted by some people as justifying a rejection of any use of counter-cyclical fiscal policy, under any circumstances.

Surely, however, not being able to fine tune the economy is not the same thing as saying that stimulus is never appropriate. Automobiles that have loose steering and uncertain acceleration are not good candidates to drive on a winding mountain road; but if one is stuck in such a car, and there is mortal danger to one's right, then turning left and flooring it is surely the better choice than saying, "Gee, this car's controls are less than certain, so let's just sit here."

Even if one objects to that analogy, moreover, the Austerions are not advocating policy stasis. If we had merely been refusing to stimulate the economy with new spending, that would be bad enough. But we are affirmatively cutting back on government spending (especially at the state and local level in the US, but quite severely in the UK and most euro zone nations), laying off workers and reducing spending quite deliberately. If the argument is that reasonable experts disagree about the wisdom of Keynesian stimulus, then surely there are even more reasonable dissenters from the idea that austerity can be expansionary. (As an aside, note that the "fiscal cliff" argument -- that the increases in taxes and cuts in government spending, set for the end of this year, will send the economy into another recession -- is at least consistent with the idea that austerity is contractionary. Yet this argument is being seized upon by those who otherwise reject Keynesian logic.)

One cannot help but suspect, therefore, that this "We just don't know enough to do anything" argument is a cynical excuse to justify what is actually a quite radical plan of action. It is true that economists continue to disagree about some aspects of the effects of stimulus policies, but the overwhelming weight of the evidence is that, under current circumstances, stimulus spending is much more likely to do good than harm, even if under other circumstances, that would not be so. That some economists are willing to misapply theories to current circumstances is troubling, but this should not prevent people from understanding that those economists are wrong, under these circumstances.

Similarly, many of those same economists argue against extending unemployment benefits, trotting out arguments that are -- at best -- relevant when the economy is not in a recession. It is hardly reasonable to say, "Well, one side says that extending unemployment benefits is good, and they have an argument that is relevant to the current circumstances, whereas the other side says that extending unemployment benefits is bad, and they have an argument that is irrelevant to the current circumstances; so we should do nothing, because there are two sides to every question."

Should we conclude that cigarettes are not harmful, because a few putative experts continue to say that the evidence is inconclusive? Should we conclude that evolution is merely a theory, because some credentialed people cast doubt? Should we say that climate change is an open question, because there are still some climate scientists who are willing to take a contrarian position? Should we say that Keynesians policies are always wrong, under every circumstance (including the current crisis), because there are some people who claim that "both sides might have a point"?

There genuinely is debate among experts about Keynesian policies -- although it is important to remember that these doubts were truly on the fringe of the profession until Barack Obama took office, when the Republicans turned to their sympathetic economist consultants to provide excuses to reject what have been truly moderate policy proposals from the president. One need not believe that all of those economists are cynical shills to believe that their currently-stated views do not undermine the wisdom of Keynesian stimulus.

We continue to suffer from an extremely bad economy. The actual content of the arguments against stimulus are either irrelevant, or unsupported by evidence. Policy makers should not throw up their hands and wait until all economists come together to speak with one voice.


David Ricardo said...

I believe you are being more generous to the Austerians than they deserve, at least with respect to the American Austerians as opposed to the European Austerians.

The European Austerians have coupled cuts in government spending with tax increases, so at least they are intellectually consistent. The American Austerians have argued the logically unsupportable position that increases in government spending will not stimulate the economy, but that reductions in taxes will. In fact, both will stimulate the economy but a tax reduction is less efficient because at least some of the reduction will be used to build idle cash balances or reduce debt, while increases in government spending will be 100% injected into the income stream.

With respect to fine tuning the economy through fiscal policy, this is possible but politics render it inoperable. For example, government spending should be concentrated in high unemployment areas, and little increases in spending are needed in places like Texas or North Dakota for example. But because of politics spending is spread around, and in many cases used to fund projects which are not economically efficient. Take a look at how the big funding for the Department of Homeland Security was allocated, much if not most of it was directed toward pork barrel projects that had little to do with protecting the nation against a terrorist attack.

Finally, it is possible that austerity can produce economic expansion but only in a high interest rate environment, where reduced fiscal deficits allow monetary policy of credit expansion and interest rate reductions. In a liquidity trap situation monetary policy is totally ineffective and expansionary fiscal policy is the only solution to expanding an underperforming economy.

This has been known for over 70 years. Unfortunately it is politically inconvenient to many, hence the austerity which is sending Europe back into recession, and the austerity that will send the U. S. back into recession in 2013 if that policy is adopted by a Republican President and Congress.

The debate about the effectiveness of Keynesian policy is a political debate, not a debate on the economics of the policy. That issue has been settled for decades. Those renown economists who support austerity do so because it fits their political philosophy on government spending and they then try to develop economic theory to support their pre-conceived policy positions. That is why their arguments, analysis and empirical data simply do not work.

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