Bill Mitchell on the Euro, Austerity and MMT

Nice, short interviews.

The Catastrophe of Ireland

It’s a catastrophe, even though some people are crowing about the admittedly large real GDP growth rates in 2014 and 2015 (at 5.2% and about 6.9% respectively). In the media, we find breathless stories about Ireland being the “fastest growing economy in Europe” as if Ireland’s brutal austerity is a viable model for the rest of Europe.

However, actual Irish real GDP still stands below its 2007/2008 peak, even after 8 years. The depth of Ireland’s collapse was on the scale of a depression (that is, where real output fell by 10% or more) and if it takes 6 years before some modest growth returns, you have to ask: how the bloody hell does anyone think this is a success story?

The Irish unemployment rate stands at 8.9% as of January 2016. This is a national disgrace.

Ireland is fast approaching ten years of high unemployment and neoliberal insanity, despite the somewhat better figures on GDP in 2014 and 2015.

Even worse, if it wasn’t for the mass emigration from Ireland since 2008, Ireland’s unemployment rate would be far higher than the 8.9% it is today, because the emigration has manifestly reduced the unemployment rate.

You Know the Mainstream European Left is Bankrupt when their Leaders can’t make Speeches like this

This is the British UKIP leader Nigel Farage speaking in the European Parliament a few days ago when the Greek Prime Minister Alexis Tsipras was present.



And, no, I haven’t gone conservative, nor would I endorse UKIP’s domestic economic policies – which would involve a nasty dose of neoliberal poison, probably worse than the conventional neoliberalism. And, yes, we all know well that some people who vote for UKIP are xenophobic and bigoted. They also have an unhinged libertarian wing, which makes me hold my nose in disgust.

Nevertheless, Farage has it right here, and the mainstream Left in Europe seems utterly bankrupt, impotent, confused and all at sea. Most of them would defend the EU and even the Euro even if it meant utter catastrophe for their own national electorates – and all from a misguided and utopian obsession with the European Union and utter incompetence when it comes to economics. However, the issue with the EU and the Eurozone is not just about economics, it is also about democracy. Democracy is becoming a farce in Europe and anyone rational on the Left should be able to see this.

Take the case of Greece: it would now appear that Syriza – despite its stunning win in the recent referendum – might actually accept more austerity, as is suggested in a fine analysis by Bill Mitchell of the whole Greek debacle here.

What is “Austerity”?

I mean in an economic context.

People sometimes seem confused about what it means, but I don’t find it problematic. In an economic context, “austerity” has this sense:

(1) a situation where the net effect of a government budget (in all its aspects whether spending or taxation, etc.) is contractionary fiscal policy in which aggregate demand is reduced or drained from the economy. E.g., the fiscal policy of Greece and Ireland after 2008 was an example of this type of austerity.

However, sometimes people use the word “austerity” in a secondary, looser sense:

(2) a situation in which a government reduces a previously expansionary fiscal policy to a much weaker one but where the net effect of fiscal policy is actually expansionary rather than contractionary. In this sense, the government “austerity” consists in the reduction of the expansionary effect of fiscal policy. E.g., it would seem that the Tory-Liberal Democrat government that ruled Britain from 2010–2015 more or less pursued this type of austerity.

When people talk of “austerity,” they usually think of type (1), and so confusion is frequently caused in political and economic debates when people use the word in sense (2).

Type (2) “austerity” means that a government is refusing to create stronger aggregate demand in an economy by cutting the strength of its fiscal stimulus to a weaker level, though in reality its fiscal policy is still (even if only weakly) expansionary. This means that the economy is forgoing a higher level of output and employment: unemployment, for example, will be higher than it needs to be. But type (2) austerity is still a form of fiscal expansion, and this should not be forgotten. An economy may well continue to have positive GDP growth and continue on a less robust growth path under type (2) austerity, since the government is not actually reducing aggregate demand in the way it would in type (1) austerity.

To avoid confusion, one has to distinguish these two senses of “austerity.”

Steve Keen on Greece, Austerity, and Post Keynesian Economics

Steve Keen recently gave a talk on Greece, austerity, and Post Keynesian economics for the Rethink­ing Eco­nom­ics stu­dent asso­ci­a­tion at the Lon­don School of Eco­nom­ics. You can get more background and lecture slides here. The video is below.

The “Success” of Austerity in Estonia: More Neoliberal and Austrian Delusions

I see some neoliberals and even Austrians have been crowing lately about the alleged “success” of austerity in Estonia:

Frank Shostak, “Why Estonia Is Beating the Eurozone,” Mises Daily, October 18, 2012.
http://mises.org/daily/6232/Why-Estonia-Is-Beating-the-Eurozone

The chief reason cited for the alleged “success” by Shostak is the fall in the unemployment rate in Estonia. Shostak asserts that unemployment “fell to 5.9 percent in August from 7.6 percent in January.” I am not sure where he gets his figures from.

According to Tradingeconomics.com, unemployment in Estonia in the second quarter of 2012 was at 10.2%. In late 2011, it was at about 11%:

http://www.tradingeconomics.com/estonia/unemployment-rate

Now it is certainly true that Estonian unemployment significantly fell from 2010 to early 2011 (from about 20% to 13%). But why did unemployment fall like this? The evidence suggests that a great deal of the fall in unemployment in these Baltic states in the years of austerity should be ascribed to mass emigration, not to strong domestic employment growth:

“… all three [sc. Baltic states] have seen mass emigration over the last four years, particularly amongst the young. All three have the highest emigration rates in the EU, with 24 people out of every 1,000 leaving Lithuania in the last year. This, in turn, has restrained domestic unemployment; and while people should be free to go and find work where they can, their exit hardly counts as a ringing endorsement for the government.”
James Meadway, “The Myth of Successful Baltic Austerity,” New Economics Foundation, 18 July 2012.

And then we get this astonishing admission from Shostak:

“Since Q2 2011 the government has reversed its stance and embarked on massive spending. The average of the yearly rate of growth between Q2 2011 and Q2 2012 stood at a positive figure of 11 percent. (Contrast this with the -7.4 percent during Q3 2009 to Q1 2011.) Furthermore, the yearly rate of growth of money supply has been displaying strong growth. The average of the yearly rate of growth between December 2009 and August 2012 stood at 8 percent. (Contrast this with the figure of -7.9 percent during May 2008 to November 2009.) Rather than persisting with the cleansing process, the government and the central bank have chosen to reverse the stance, thereby arresting the process of healing the economy.”
Frank Shostak, “Why Estonia Is Beating the Eurozone,” Mises Daily, October 18, 2012.
http://mises.org/daily/6232/Why-Estonia-Is-Beating-the-Eurozone

So in truth Estonia has from quarter 2, 2011 embarked on fiscal expansion to some degree (just how significant I don’t know, without further research).

That fiscal expansion is correlated with the higher GDP growth rates that occurred from 2011:

http://www.tradingeconomics.com/estonia/gdp-growth-annual

So whatever one wants to argue about the strong growth rates and recovery from 2011 (which was probably due to export-led growth to some degree as well), it was not correlated with austerity at that time.

In general, if your model of economic policy is to drive a significant proportion of the population overseas, owing to the social devastation caused by domestic wage and price deflation (what seems to have happened in the Baltic states from 2008–2011), then no doubt you can declare a “success” story.

Those of us not in thrall to neoclassical or Austrian economics will not be convinced or impressed by such balderdash, however.


BIBLIOGRAPHY
James Meadway, “The Myth of Successful Baltic Austerity,” New Economics Foundation, 18 July 2012
http://www.neweconomics.org/blog/2012/07/18/the-myth-of-successful-baltic-austerity

Austrians Can’t Get their Story Straight on the Effects of Austerity

Here is something I have noticed of late in the ongoing debates on austerity: some Austrians argue that fiscal contraction can directly lead to GDP growth and recovery (a line taken by some neoclassical economists with their pro-growth austerity fables), and they argue that, if only governments would do nothing and pursue austerity, strong recoveries would ensue. In the process, these Austrians seem to deny that recession or depression is the result of fiscal contraction.

The idea is blatantly contradicted by their own business cycle theory, which holds that prolongation of a recession or depression to its “natural” end, and purging malinvestments in the process, is a necessary consequence of the “do nothing” response itself (called “liquidationism”). Therefore it is bizarre and stupid in the extreme for any Austrian adherent of the Hayekian business cycle theory to argue that austerity or a “do nothing” policy will lead directly to growth.

Before he renounced liquidationism, Hayek in Prices and Production explained exactly why nothing must be done during a credit-caused recession, and why the economy and society must suffer the consequences:

“If the foregoing analysis is correct, it should be fairly clear that the granting of credit to consumers, which has recently been so strongly advocated as a cure for depression, would in fact have quite the contrary effect; a relative increase of the demand for consumers’ goods could only make matters worse. Matters are not quite so simple so far as the effects of credits granted for productive purposes are concerned. In theory it is at least possible that, during the acute stage of the crisis when the capitalistic structure of production tends to shrink more than will ultimately prove necessary, an expansion of producers’ credits might have a wholesome effect. But this could only be the case if the quantity were so regulated as exactly to compensate for the initial, excessive rise of the relative prices of consumers’ goods, and if arrangements could be made to withdraw the additional credits as these prices fall and the proportion between the supply of consumers’ goods and the supply of intermediate products adapts itself to the proportion between the demand for these goods. And even these credits would do more harm than good if they made roundabout processes seem profitable which, even after the acute crisis had subsided, could not be kept up without the help of additional credits. Frankly, I do not see how the banks can ever be in a position to keep credit within these limits.

And, if we pass from the moment of actual crisis to the situation in the following depression, it is still more difficult to see what lasting good effects can come from credit expansion. The thing which is needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand, it must mean that part of the available resources is again led into a wrong direction and a definite and lasting adjustment is again postponed. And, even if the absorption of the unemployed resources were to be quickened in this way, it would only mean that the seed would already be sown for new disturbances and new crises. The only way permanently to “mobilize” all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes.

(10) And so, at the end of our analysis, we arrive at results which only confirm the old truth that we may perhaps prevent a crisis by checking expansion in time, but that we can do nothing to get out of it before its natural end, once it has come.” (Hayek 2008: 274–275).

In other words, if we take the logic of this Hayekian solution of liquidationism seriously, honest Austrians should be telling us that their solution requires recession or depression, possibly protracted and devastating depression, which must be allowed to continue until it reaches its “natural end.”

Of course, these ideologues are wrong for the simple reason that their business cycle theory is hogwash.

Moreover, an approximation* of the Hayekian liquidationist “do nothing” approach was taken by Chancellor Brüning in Weimar Germany. The depression and suffering to which the Germans were subjected did not have encouraging results:

“… the German authorities responded to their external difficulties by depressing their internal economy. Schacht, president of the Reichsbank until March 1930 and chief German negotiator for the Young Plan, had consistently pursued a deflationary strategy. Hans Luther, his successor at the Reichsbank, followed suit, keeping the discount rate well above the rates in London and New York in attempt to reduce the bank’s continuing loss of gold ... the fiscal authorities were even more aggressive in their deflationary efforts. The move toward highly restrictive government budgets came in the beginning of 1930. Heinrich Brüning, chancellor from March 1930 to May 1932, continued this, relentlessly attempting to deflate the economy to restore equilibrium in the manner of the gold standard. Germany, unable to pay its foreign bills at gold par, had to reduce internal prices until it could” (Temin 1989: 30–31).

“Economic breakdown [sc. during the Great Depression] led to political upheaval which in turn destroyed the international status quo. Germany was the most striking example of this complex interaction. Without the depression Hitler would not have gained power. Mass unemployment reinforced all the resentments against Versailles and the Weimar democracy that had been smouldering since 1919. Overnight the National Socialists were transformed into a major party; their representation in the Reichstag rose from 12 deputies in 1928 to 107 in 1930. The deflationary policies of the Weimar leaders sealed the fate of the Republic” (Adamthwaite 1977: 34).

A call for liquidationism is nothing less than a call for mass unemployment, impoverishment, starvation, homelessness, breakdown of families, and society – and the political system. In societies with militant extremes on the left or right, authoritarianism may well result.

What is especially telling is that not even Hayek was so stupid as some of his modern followers in calling for a “do nothing” policy as an actual solution to downturns in the business cycle, because
Hayek eventually renounced liquidationism at some point after 1933.

Hayek even went so far as to say that “liquidationism” as a serious policy in Germany in 1930 was, in essence, sheer madness and would lead to revolution:

“… a ‘secondary depression’ caused by an induced deflation should of course be prevented by appropriate monetary counter-measures. Though I am sometimes accused of having represented the deflationary cause of the business cycles as part of the curative process, I do not think that was ever what I argued. What I did believe at one time was that a deflation might be necessary to break the developing downward rigidity of all particular wages which has of course become one of the main causes of inflation. I no longer think this is a politically possible method and we shall have to find other means to restore the flexibility of the wage structure than the present method of raising all wages except those which must fall relatively to all others. Nor did I ever doubt that in most situations employment could be temporarily increased by increasing money expenditure. There was one classical occasion when I even admitted that this might be politically necessary, whatever the long run economic harm it did.

The occasion was the situation in Germany in, I believe, 1930 when the depression was beginning to get quite serious and a political commission—the Braun Committee—had proposed to combat it by reflation (though that term had not yet been coined), i.e., a rapid expansion of credit. One of the members of the committee, in fact the main author of the report, was my late friend, Professor Wilhelm Röpke. I thought that in the circumstances the proposal was wrong and wrote an article criticising it. I did not send it to a journal, however, but to Professor Röpke with a covering letter in which I made the following point:

‘Apart from political considerations I feel you ought not—not yet at least—to start expanding credit. But if the political situation is so serious that continuing unemployment would lead to a political revolution, please do not publish my article. That is a political consideration, however, the merits of which I cannot judge from outside Germany but which you will be able to judge.’

Röpke’s reaction was not to publish the article, because he was convinced that at that time the political danger of increasing unemployment was so great that he would risk the danger of causing further misdirections by more inflation in the hope of postposing the crisis; at that particular moment this seemed to him politically necessary and I consequently withdrew my article.

To return, however, to the specific problem of preventing what I have called the secondary depression caused by the deflation which a crisis is likely to induce. Although it is clear that such a deflation, which does no good and only harm, ought to be prevented, it is not easy to see how this can be done without producing further misdirections of labour. In general it is probably true to say that an equilibrium position will be most effectively approached if consumers’ demand is prevented from falling substantially by providing employment through public works at relatively low wages so that workers will wish to move as soon as they can to other and better paid occupations, and not by directly stimulating particular kinds of investment or similar kinds of public expenditure which will draw labour into jobs they will expect to be permanent but which must cease as the source of the expenditure dries up.” (Hayek 1978: 210–212).

At the end of this passage, Hayek advocates public works as a solution to “secondary deflation,” so modern Austrian advocates of pure and absolute liquidationism take a view that even Hayek rejected.


Further Reading
See my posts here:

“Did Hayek Advocate Public Works in a Depression?,” September 25, 2011.

“When Did Hayek Renounce Liquidationism?,” January 1, 2012.

“Austerity and the Weimar Republic ,” June 5, 2011.

Note

* I say “approximation” because Austrians are like Marxists: Marxists, when confronted with real world examples of Marxist systems that are horror stories, will say that it was not “real” Marxism. When approximate empirical evidence of real world examples of their policy prescriptions are cited, showing that they don’t work, the Austrian response is usually: “it wasn’t really pure liquidationism!”

BIBLIOGRAPHY

Adamthwaite, A. P. 1977. The Making of the Second World War, Allen & Unwin, London and Boston.

Hayek, F. A. von. 1978. New Studies in Philosophy, Politics, Economics, and the History of Ideas, Routledge & Kegan Paul, London.

Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala.

Temin, P. 1989. Lessons from the Great Depression, MIT Press, Cambridge, Mass.

Did Anders Borg Pursue Austerity in Sweden in 2009 and 2010?

The right wing press is all aglow with paeans to the Swedish finance minister Anders Borg. See these articles:

Veronique de Rugy, “GDP Growth Rates: The Swedish Approach,” Mercatus Center, May 16, 2012.

Fraser Nelson, “Sweden’s Secret Recipe,” The Spectator, 14 April 2012.

The conservatives appear to be asserting that Sweden’s recovery from the 2008–2009 recession was the result of austerity, and the tax cuts Borg passed in 2007. Unfortunately, this nonsense falls apart when we look at the facts.

Anders Borg became finance minister on 6 October 2006. The government passed tax cuts in January 2007, long before financial crisis of 2008 and global recession. But what kind of tax cut did Borg oversee? Apparently, they involved tax cuts for lower income earners as well as upper income earners:

“What even Borg did not expect was that his tax cut for the low-paid would increase economic growth so much that it has almost entirely paid for itself. Borg had created something that Osborne’s critics say does not exist: a self-financing tax cut. ‘There was some criticism at the time that we were borrowing to finance tax cuts,’ he says. But Sweden could do it, because it was expecting to return to surplus soon.”
Fraser Nelson, “Sweden’s Secret Recipe,” The Spectator, 14 April 2012.

If Sweden was borrowing money to finance tax cuts, then there must have been a resulting deficit, but strangely there doesn’t appear to have been a deficit in 2007:

Swedish Government Budget Surplus/Deficit as % of GDP
2005 1.95%
2006 2.22%
2007 3.53%
2008 2.20%
2009 -1.18%
2010 -1.17%

So I do not know exactly what was going on here: whatever fiscal effect the tax cut had is unclear to me, but the crucial point is that this tax cut happened in 2007.

When the global recession struck in 2008, what did Sweden do? It adopted a Keynesian stimulus package, and expansionary fiscal policy in 2009 and 2010. In December 2008, the Swedish government announced an 8 billion kronor (757 million euros, $966 million) stimulus package, implemented in 2009.

The 2010 budget was also expansionary, and Anders Borg, the man himself, said so:

“Sweden’s centre-right government presented on Monday an expansive 2010 budget bill focused on job creation and economic stimulus to lift Sweden out of the crisis a year ahead of general elections. ‘We are trying to limit damage from the crisis by taking forceful action to promote jobs and enterprise and by providing support to everyone who has been severely hit by unemployment,’ Finance Minister Anders Borg said.”
Economic Stimulus to Lift Sweden out of the Crisis, The Swedish Wire, 21 September 2009.

The Swedish economy was lifted out of its recession around the middle of 2009, owing to the stimulus. The belief that tax cuts in 2007 (whose actual fiscal effects are unclear) caused a recovery in mid-2009 is ridiculous beyond words.

Another ridiculous and misleading trick of conservatives to say that Swedish government spending as a percentage of GDP fell from 52.9% in 2006 to 51.8% in 2011, and then imply that this was the reason for the recovery. Yet the actual figures show a large increase in government spending as a percentage of GDP during the recession and economic crisis:

Swedish Government Spending as % of GDP
2006 52.9%
2007 51.0%
2008 51.7%
2009 55.2%
2010 53.0%

Note the huge surge from 2008–2009 (partly, of course, a function of falling GDP from 2008–2009, but also a result of automatic stabilisers and stimulus spending).

Then the percentage falls once the recovery occurred and the stimulus did its work, causing private sector growth, and rising GDP and tax revenues.

All precisely predictable and consistent with Keynesian economics.

Lithuania: Another Baltic Disaster

I’ve done a post on austerity in Latvia here. A good overview of what has happened in Lithuania can be found in this article:

Jeffrey Sommers, Arunas Juska, and Michael Hudson, “‘No People, No Problem’: The Baltic Tigers’ False Prophets of Austerity,” Counterpunch, December 6, 2011.

In short, the migration effect of austerity and internal devaluation has actually been worse in Lithuania than in Latvia!

Some 83,200 Lithuanians emigrated in 2010, the highest level of emigration since 1945. In 2008, the emigration rate was the highest in the EU countries (2.3 per 1,000), and forecasts predict a population decline of a further 10.9 per cent for 2008–2035.

This can only mean that the fall in official unemployment from 18.3% in summer 2010 to 13.9% in January 2012 must be more the result of the emigration of sectors of the labour force, than of domestic employment growth. Thus any employment “success” in Lithuania is sheer delusion.

As for real GDP, it contracted by 14.8% in 2009 – that is to say, Lithuania was hit by an actual depression in that year. Growth was a mild 1.4% in 2010, which was nothing to boast about.

In 2011, it was 5.9% (for figures, see here). The moderate growth rate for 2011 may well be the result of export-led growth, but the truth is that the price was appallingly high and utterly unnecessary.

Why? The reason is that any export-led growth that Lithuania – or indeed any of the Baltic nations – experienced in 2010–2011 could have been achieved by currency depreciation of their own independent currencies, which would have allowed a space for stimulating the domestic economy by Keynesian fiscal expansion.

Taking Keynes’s Name in Vain

That title refers to what is now an almost notorious 2011 article by Vince Cable, the UK Secretary of State for Business, Innovation and Skills, which defends the Tory-Liberal Democrat coalition regime of austerity in Britain:

Vince Cable, “Keynes Would be on Our Side,” New Statesman, 12 January 2011.

There are already good responses from David Blanchflower and Robert Skidelsky and partly from Bill Mitchell.

I suppose part of the problem is that Keynes moved through various stages in his economic thinking, from being essentially a typical liberal before 1914 in favour of free trade, to a quasi-monetarist, to the Keynes of the General Theory in favour of stabilisation of investment and fiscal activism. Which Keynes are people claiming?

For me it would be the Keynes who praised the work of Abba Lerner (1943; 1944; and 1951), the man who really did develop the modern Keynesian policy of active fiscal management of an economy.

After some initial dismissal of some of Lerner’s ideas (perhaps even hostility) at a lecture at the Federal Reserve in 1943, Keynes withdrew this opposition. This is related by David Colander:

“Keynes retracted his characterization of Lerner’s ideas as ‘humbug.’ According to Lerner, ‘in reading … [The Economics of Control] later, at leisure, … [Keynes] found the logic less escapable and the resistances more obvious’ … Keynes admitted to being at least a closet Lernerian in a letter to Lerner (September 1944) congratulating him on The Economics of Control. Keynes wrote:

‘I have marked with particular satisfaction and profit three pairs of chapters-chap. 20 and 21, chap. 24 and 25 [where Lerner had discussed functional finance], chap. 28 and 29. Here is the kernel of yourself. It is very original and grand stuff. I shall have to try when I get back to hold a seminar for the heads of the Treasury on Functional Finance. It will be very hard going-probably impossible. I shall have to temper its austerity where I can. I think I shall ask them to let me hold a seminar of their sons instead, agreeing beforehand that, if I can convince the boys, they will take it from me that it is so!’

It was not only in this letter that Keynes retracted his initial remarks about Functional Finance. In 1945, when Keynes again visited the United States, he repeated his praise of Lerner at another Federal Reserve Seminar. In this meeting Keynes spoke in glowing terms of Lerner’s contribution and ‘without any provocation, he held forth a panegyric on Functional Finance’” (Colander 1984: 1574).

BIBLIOGRAPHY

Colander, D. 1984. “Was Keynes a Keynesian or a Lernerian?” Journal of Economic Literature 22.4: 1572–1575.

Lerner, A. P. 1943. “Functional Finance and the Federal Debt,” Social Research 10: 38–51.

Lerner, A. P. 1944. The Economics of Control, New York, Macmillan.

Lerner, A. P. 1951. The Economics of Employment, New York, McGraw Hill.

Robert Pollin Debunks Arguments for Austerity

A nice interview here with Robert N. Pollin (professor of economics at the University of Massachusetts-Amherst) on the Real News Network, who debunks the arguments for austerity. I think this was originally done in 2010, but it is just as relevant today.

Debunking Catalán on the Recession of 1937-1938

Jonathan M. Finegold Catalán attempts to prove that the recession of 1937–1938 was not caused by contractionary fiscal and monetary policy:

Jonathan M. Finegold Catalán, “Dangerous Lessons of 1937,” Mises Daily, February 2, 2010.

I. The Data
First, some basic facts about the recession and data:

(1) In the US, the fiscal year before 1976 ran from July 1 to June 30 in the next year. So in the relevant years the actual fiscal years were as follows:

Roosevelt inaugurated March 4, 1933.
Fiscal 1934: July 1, 1933 – June 30, 1934
Fiscal 1935: July 1, 1934 – June 30, 1935
Fiscal 1936: July 1, 1935 – June 30, 1936
Fiscal 1937: July 1, 1936 – June 30, 1937
Fiscal 1938: July 1, 1937 – June 30, 1938
Fiscal 1939: July 1, 1938 – June 30, 1939
Fiscal 1940: July 1, 1939 – June 30, 1940

In analysing the effects of fiscal policy in these years, one should not confuse the calendar year with the fiscal year: these are two different things.

(2) The actual recession (economic contraction) ran from May 1937 to June 1938.¹ Thus the contraction began in the last months of fiscal year 1937 and lasted until the end of fiscal year 1938.

(3) Data on the Federal budget can be found here:

Federal Budget Receipts and Outlays: Coolidge – Obama.

(4) Data on total government spending (including local, state and federal) can be found here:

Total US Government Spending in billions of dollars.

The figures on total government spending (state, local, federal):

Year Outlays
1933 $12.62
1934 $12.81
1935 $14.78
1936 $16.76
1937 $17.22
1938 $17.68
1939 $19.05
1940 $20.42

Now these figures do not show us whether increases in total government spending were expansionary or contractionary, as one needs to look at whether the spending increases occurred by deficit spending or merely out of current revenues.

II. Critique
Let us now refute and correct Catalán’s assertions and errors here:

(1) Catalán states that

“The idea that Herbert Hoover was a laissez-faire president and that Roosevelt's New Deal paved the road to recovery have been refuted elsewhere.”

I have already refuted the Austrian attempts to paint Herbert Hoover as some radical interventionist president or big-spending Keynesian here:

“Herbert Hoover’s Budget Deficits: A Drop in the Ocean,” May 24, 2011.

Hoover adopted some very limited policy interventions and very mild increases in federal government spending from 1929–1932, but these were almost completely destroyed by state and local austerity.

(2) Catalán states that

“Interestingly, during 1935 — a year considered one of recovery — total government outlays measured $6.4 billion, less than during both 1936 and 1937. In fact, looking back to the years from 1933 to 1935, government spending peaked at $6.5 billion in 1934. It suffices to say that explaining Roosevelt's recession by pointing at a decrease in government spending is severely dishonest.”

Catalán commits the red herring fallacy, and is laughably ignorant of basic Keynesian theory: to gauge the effects of fiscal policy in any particular year and to see whether it was expansionary or contractionary, one must look at

(1) the size of the deficit and whether there was increased spending done via deficits, not just the size of spending per se;
(2) whether tax policy changed and if revenues rose owing to tax increases, and
(3) not just federal spending by itself, but total government spending at the local, state and federal level, to see if the net effect of deficit spending was expansionary.

In fact, total government spending in fiscal years 1935 and 1936 was highly expansionary:

Year* Total Outlays
1933 $12.62
1934 $12.81
1935 $14.78
1936 $16.76
1937 $17.22
1938 $17.68
1939 $19.05
1940 $20.42
*the fiscal year

The expansionary effect of fiscal policy in these years must be attributed to the large federal deficits. In fiscal year 1934 there had been a large deficit, but its expansionary effect was reduced to some extent by state and local austerity. In the fiscal years 1935 and 1936 federal deficits overcame that state and local austerity and imparted significant stimulus at a time when the financial system had been stabilised and monetary policy aided recovery.

It is no surprise that GDP soared in these years, with growth rates of 8.1% (1935) and 14.1% (1936). In 1937 and 1938, Roosevelt turned to budget balancing: the result was that federal deficit was virtually eliminated by fiscal year 1938 by

(1) the raising of taxes (which contracted private spending power), and
(2) reducing overall federal spending.

This shows up in the figures above for total government spending for 1937 and 1938, where total spending barely moved, and was at any rate offset by contractionary state and local fiscal policy, as in 1934 (Cary Brown 1956: 867–868).

In fact, the role of state and local governments during the depression was deeply contractionary most of the time:

“The nation’s fiscal policy throughout the Great Depression included the fiscal actions of state and local governments as well as of the federal government. During the early years of the depression, state governments increased spending for unemployment relief, primarily through subventions to local governments, which faced sharply declining property tax revenues, soaring rates of default, and even popular revolts, including a tax strike in Chicago. They did so by increasing sales taxes and by reducing spending on public works, especially highways, and schools. State constitutions, however, limited deficit finance, and new state and municipal bonds were extremely difficult to market. As the Depression worsened in 1931 and 1932, state and local governments found it impossible to conduct business as usual and still balance their budgets. State and local governments began adopting drastic economies, scaling back total expenditures in 1931 and sharply contracting them in 1933 and 1934. State governments welcomed federal funding of unemployment relief and public works, although they resisted the requirement of the Federal Emergency Relief Administration and the PWA for state matching funds. When economic recovery advanced, particularly in 1936 and 1938, state and local governments resumed spending on public works and education and thus once again increased their total outlays. Sharp increases in tax rates, however, erased any stimulative effect of state and local spending. State and local governments had pushed up tax rates every year between 1929 and 1933, and maintained those high levels until 1936, when they undertook even further increases. State governments increased the scope and rates of their sales taxes until, in 1940, they raised most of their funds through such levies.” (Elliot Brownlee 2000: 1044).

What was also deeply contractionary was the fact that state and local governments were running surpluses:

“Over the same seven years [sc. 1932–1938], state and local government revenues increased—principally from higher taxes—at a faster rate than expenditure.” (Bagwell and Mingay 1987: 282).

What the figures for total government spending (state, local and federal) from 1937–1938 tell us is that, while state and local governments did increase spending (which led to an overall increase in total government spending in each year), they

(1) did so by raising taxes (which did not stimulate the economy), and

(2) they even ran surpluses, which drained even more spending power from the economy, an astonishingly anti-Keynesian thing to do at a time when the economy needed countercyclical fiscal policy.

State and local government contractionary fiscal policy in 1937 and 1938 was thus caused by (1) raising taxes and (2) running surpluses.

The net effect of government fiscal policy in 1937 was to cause “a shift in demand of over [2.5] per cent of GNP in one year” (Cary Brown 1956: 866).

Catalán also ignores the following:

(1) in June 1936, the Revenue Act passed Congress and caused a significant increase in income tax rates, as well as the tax on undistributed profits. The main effect of the tax on undistributed profits was to adversely affect the cost of investment for small and medium-sized firms. There is a reasonable case to be made that this tax increased business uncertainty about profitability of investment.

(2) collection of the Social Security tax began in January 1937, another tax measure contracting private spending power.

(3) The Fed increased Reserve requirements on July 14, 1937 and this went into effect the next month; the second and third increases in reserve requirements were announced on January 30, 1937, and came into effect on March 1 and May 1 respectively. From December 1936, the treasury began to sterilise gold inflows into the United States by using proceeds of bond sales to pay for gold brought to the treasury. From December 1936 to February 1938 the monetary base grew by only 4% while gold stock grew by 15%.

The tax increases reduced the federal deficit very significantly indeed by fiscal year 1938, by causing revenues to rise. The net effect of all this when combined with federal spending cuts was highly contractionary: this was the cause of the 1937–1938 recession.

(3) Catalán ignores the fact that the Federal deficit was almost abolished in fiscal year 1938. Catalán states:

“It is not much more useful to look at deficit spending. True, deficit spending in 1937 was at its lowest since 1933, but it is worth mentioning that in 1938 — the same year as the economy rebounded from the 1937 dip — total government deficit spending amounted to only $89 million.”

In a strange non sequitur Catalán notes in passing that the deficit was massively reduced in fiscal year 1938 (July 1, 1937 – June 30, 1938): in fact, it was virtually eliminated and caused contractionary fiscal policy. The deficit in fiscal year 1938 was the lowest ever in all the years from 1931–1941. In terms of its fiscal impact, the federal budget was almost balanced in fiscal year 1938.

Catalán also confuses the fiscal year with the calendar year. Some data:

(1) The actual recession (economic contraction) ran from May 1937 to June 1938.

(2) Fiscal years:
Fiscal 1937: July 1, 1936 – June 30, 1937
Fiscal 1938: July 1, 1937 – June 30, 1938
Fiscal 1939: July 1, 1938 – June 30, 1939.

The recovery began in July 1938, which is in fiscal year 1939. Most of the actual recession coincided with fiscal year 1938, precisely the year when the deficit had been nearly abolished.

It was only in about April 1938 that Roosevelt turned once again to expansionary fiscal policy and ended the austerity programs. It was no surprise that some months later the recession ended, and economy began to grow again, and entered another expansionary phase of real GNP growth, as the federal deficit soared to $2.8 billion in fiscal year 1939 (July 1, 1938–June 30, 1939).

FOOTNOTES
(1) There seems to be some disagreement about when the recession ended. Cf. Gene Smiley (1997: 154), who states that the recession lasted from May 1937 until August 1938. The official NBER chronology, however, shows a recession from May 1937 to June 1938.

BIBLIOGRAPHY

Bagwell, P. S. and G. E. Mingay, 1987. Britain and America 1850–1939: A Study of Economic Change (2nd edn.), Routledge, London.

Cary Brown, E. 1956. “Fiscal Policy in the ’Thirties: A Reappraisal,” American Economic Review 46.5: 857–879.

Elliot Brownlee, W. 2000. “The Public Sector,” in S. L. Engerman and R. E. Gallman (eds), The Cambridge Economic History of the United States. Volume 3. The Twentieth Century, Cambridge University Press, Cambridge. 1013–1060.

Gene Smiley, W. 1997. “Depression of 1937–1939,” in D. Glasner and T. F. Cooley (eds), Business Cycles and Depressions: An Encyclopedia, Garland Pub., New York. 154–155.

What Austerity Wrought in Latvia

With the Republicans basically preparing to destroy the US economy over the debt ceiling, we might wonder what severe austerity means in human terms. For this, we can go back to 2009 and review the wonderful “achievements” of austerity in Latvia, as displayed in the video below, where an unusually extreme form of it was imposed on the population.

At one point Latvia’s unemployment rate hit 20.1% (December 2009), and by some reports was 22.9% in January 2010, the worst in the EU (it is unclear whether this is data from the Latvian State Employment Agency which provides the official registered unemployment rate, or a better estimate). In the first quarter of 2011, the unemployment rate was 16.9%, and the reported registered unemployment rate as of July 2011 was a lower but still disastrous double-digit figure of 12.4% (and that might, at any rate, be an underestimate).

GDP growth in Q1 2001 was a miserable 0.2%. All in all, a wretched result after the level of suffering that was inflicted on the country.

The export-led growth that the country has experienced in 2010–2011 could have been achieved by currency depreciation, which would have allowed a space for stimulating the domestic economy as well.

Austerity and the Weimar Republic

With the neoliberal press gloating over what they perceive as the “success” of austerity in the Baltic states, a question poses itself: what happens when this type of brutal wage and price deflation is inflicted on an advanced capitalist nation?:

“The [sc. Weimar] German government struggled, however, within the confines of the rules of orthodox finance, that is, the gold standard. As the downturn began due to the combination of American and German policies already described, the German authorities responded to their external difficulties by depressing their internal economy. Schacht, president of the Reichsbank until March 1930 and chief German negotiator for the Young Plan, had consistently pursued a deflationary strategy. Hans Luther, his successor at the Reichsbank, followed suit, keeping the discount rate well above the rates in London and New York in attempt to reduce the bank's continuing loss of gold ... the fiscal authorities were even more aggressive in their deflationary efforts. The move toward highly restrictive government budgets came in the beginning of 1930. Heinrich Brüning, chancellor from March 1930 to May 1932, continued this, relentlessly attempting to deflate the economy to restore equilibrium in the manner of the gold standard. Germany, unable to pay its foreign bills at gold par, had to reduce internal prices until it could” (Temin 1989: 30–31).

“Economic breakdown [sc. during the Great Depression] led to political upheaval which in turn destroyed the international status quo. Germany was the most striking example of this complex interaction. Without the depression Hitler would not have gained power. Mass unemployment reinforced all the resentments against Versailles and the Weimar democracy that had been smouldering since 1919. Overnight the National Socialists were transformed into a major party; their representation in the Reichstag rose from 12 deputies in 1928 to 107 in 1930. The deflationary policies of the Weimar leaders sealed the fate of the Republic” (Adamthwaite 1977: 34).

One also wonders how an “Austrian” policy of dismantling government and complete privatisation (anarcho-capitalism) or even more savage government spending cuts and abolition of the central bank (Misesian Classical liberalism) would not have collapsed the Weimar economy to even greater extent, and inflicted even greater suffering on the German people, radicalizing them even further and driving them into hands of extremists like communists and Nazis.

And, no, I am not saying that Baltic-style austerity in the US, the UK or Germany will lead to fascism, but it will result in greater votes for extremists of either the right or left. Not only are such deflationary polcies wrong on economic grounds, but also their social effects are too high a price to pay, and the worst case political outcomes of deflationary depression are catastrophic for human civilization. This is another reason why the 1930s Hayekian solution of doing nothing in response to depression was morally objectionable to many people.


BIBLIOGRAPHY

Adamthwaite, A. P. 1977. The Making of the Second World War, Allen & Unwin, London and Boston. p. 34.

Temin, P. 1989. Lessons from the Great Depression, MIT Press, Cambridge, Mass.

A New Post at Cynicus Economicus

I see with some interest that the Cynicus Economicus blog has a new post, which I urge people to read:

“An Occasional Return,” April 27, 2011.

There are some comments on the UK, as follows:

“The simple fact of the matter is that, despite talk of austerity, the UK government continues upon its binge of borrowing and spending …. The UK economy is still sitting upon the life support of government borrowing, and has yet to face what might happen when the borrowing stops, and repayment starts. Even with the linked inflation and currency devaluation, the UK debt position remains in a dire position.”

In reality, the UK government-debt-to-GDP ratio is about the middle of the range and (for the UK) not historically that large:

List of sovereign states by public debt

UK National Debt Charts, Three Centuries of the National Debt.

Both Germany (at 83.20%) and France (at 81.70%) have worse government-debt-to-GDP ratios, yet the sky is not falling in those nations.

The fact that government borrowing has continued and the government-debt-to-GDP ratio has risen under the Tories is not even remotely surprising. Why? First, the real effects of austerity are only kicking in this year, and, secondly, there is already ample evidence that, without truly extreme cuts, austerity causes the budget deficit to get worse, as economic activity and tax revenues plunge, and more people become unemployed and claim social security from the state.

Take a look at Ireland. Ireland rejected Keynesian stimulus, and implemented austerity early. The result? By 2009, it already had the biggest budget deficit in Europe in terms of the percentage of its GDP. The country suffered a depression and the government-debt-to-GDP ratio is now 123.80%. Stunning proof of the success of this type of austerity?

The apologists for austerity will perhaps complain that the cuts weren’t deep enough. To really cut government spending and debt the austerity has to be so brutal that the country is plunged into severe depression and people are driven overseas. This is what has happened in Latvia:

“Neoliberal austerity [sc. in Latvia] has created demographic losses exceeding Stalin’s deportations back in the 1940s (although without the latter’s loss of life). As government cutbacks in education, healthcare and other basic social infrastructure threaten to undercut long-term development, young people are emigrating to better their lives rather than suffer in an economy without jobs. More than 12% of the overall population (and a much larger percentage of its labour force) now works abroad. Children (what few of them there are as marriage and birth rates drop) have been left orphaned behind, prompting demographers to wonder how this small country can survive. So unless other debt-strapped European economies with populations far exceeding Latvia’s 2.3 million people can find foreign labour markets to accept their workers unemployed under the new financial austerity, this exit option will not be available.”
Michael Hudson and Jeffrey Sommers, “Latvia provides no magic solution for indebted economies,” Guardian, 20 December 2010.

Perhaps there are some who want to claim that this is actually a vindication of their approach to economics.

Fortunately, the economic theory behind austerity of any type is deeply flawed, and an alternative is available to us: Post Keynesian economics.

Austerity: The New Cross of Gold

Some human beings are charismatic and spell-binding orators. William Jennings Bryan (1860–1925) was such a person. He can be seen in the photo below.

Bryan’s speech to the Democratic National Convention in 1896 was one remembered in history, for good reasons. Of course, human beings are human beings. I suspect that no human being can be right on every social, economic and cultural issue of his/her day. William Jennings Bryan was wrong on prohibition and in his opposition to Darwin’s theory of evolution, though not in his opposition to the vile Social Darwinism that was popular in his time.

He was also absolutely right in his denunciation of the gold standard. To this day, his speech opposing it remains one that will inspire all those fighting against wrong-headed, false, and pernicious economic doctrines. His metaphor of the “cross of gold” is a vivid one, which invokes images that will move anyone with a Christian cultural background. You do not need to believe in god (I personally don’t) to find the metaphor and speech poignant and powerful.

The metaphor has also been used by Post Keynesians and progressive New Keynesians like Paul Krugman in denunciations of modern neoclassical economics.

The crescendo of William Jennings Bryan’s speech can be heard in an audio recording he made later in 1921 that captures the mesmerising spirit of that speech. You can hear it in the YouTube link below.



At the end of his address he proclaimed:

“If they dare to come out in the open field and defend the gold standard as a good thing, we shall fight them to the uttermost, having behind us the producing masses of the nation and the world. Having behind us the commercial interests and the laboring interests and all the toiling masses, we shall answer their demands for a gold standard by saying to them, you shall not press down upon the brow of labor this crown of thorns. You shall not crucify mankind upon a cross of gold.”

Now, while many of the “commercial interests” of the world may well line up behind the advocates of austerity these days, just replace the words “cross of gold” with “austerity” and you have a perfect denunciation of the madness that is gripping policy-makers all over the world today.

If we want a good example of what extreme domestic wage and price deflation does to a country, then we need look no further than the brutal neoliberal austerity in Estonia and Latvia. In a somewhat less extreme form, it was been pursued in Ireland too, although Irish voters recently delivered their rather vehement rejection of the neoliberal assault on them.

That means nothing to Obama and the US Democrats, who announced a budget on February 14th, in which there are plans to cut $1.1 trillion in spending over 10 years, including heating subsidies for the poor. Do we need any further proof of the moral bankruptcy of the US Democratic party? But, then, they have always essentially been a party of business. What do they care if U-6 — the most reliable government measure of unemployment — stands at about 16%, and the Shadowstats.com estimate (perhaps more accurate) has hit a shocking 22%? After all, they have more important things like non-problem of the deficit (which, at any rate, would just fall naturally if the economy returned to full employment and progressive tax reforms were implemented in the next boom period). But let us move on.

In the UK, austerity is being pursued by the coalition government. And, while we expected this economic illiteracy from the Tories, the more insulting development, to many people, is the behaviour of the Liberal Democrats, who may well go down as the worst sell outs in British political history (though I personally doubt whether the Lib Dems were ever progressive on economics).

It is of course a shame to see the political descendants of Lloyd George’s 1929 Liberal party morphed into a neoliberal party in bed with the Tories. Contrast today’s “liberals” with those of 1929 who, when the UK was experiencing high involuntary unemployment, took advice from John Maynard Keynes and announced their radical plan to use fiscal stimulus and employment programs to cure the economic malaise (see Bill Mitchell, “We can conquer unemployment,” Billy Blog, September 24th, 2010).

The Liberals’ stirring election manifesto in 1929 was called “We can Conquer Unemployment!,” and it proclaimed:

“The word written to-day on the hearts of British people, and graven on their minds is Unemployment. For eight years, more than a million British workers, able and eager to work, have been denied the opportunity. At the end of 1928 the total reached a million and a half; a quarter of a million more than a year before. These workers with their dependants, represent four or five million souls. They are a very nation, denied the opportunity to earn their daily bread, condemned to hardship, to wearing anxiety and often to physical and mental demoralisation. What a tragedy of human suffering; what a waste of fine resources; what a bankruptcy of statesmanship!”

Indeed. But one will look in vain for a major party like that in the UK today.

In Australia, the ruling Labour coalition government is pursing a fiscally conservative policy of levying special taxes to pay for the reconstruction after the disastrous floods and cyclone, while the clueless Liberal party wants to cut spending to pay for reconstruction. The only sensible policy is more fiscal stimulus in Australia (or just restore Australia’s former tap system of issuing bonds), which is needed anyhow given the country’s relatively high involuntary unemployment.

In fact, all these countries are badly in need of further stimulus and major reforms in economic policy. At this point, the banks may as well be nationalised and turned into public utilities. Financial regulation needs to be imposed on the financial sector, even investment banks to some extent. Commodity buffer stocks are also a must — the world requires an effective policy to stabilise the price of food and other basic commodities, before we have a repeat of the food riots and chaos that broke out in 2008.

The beginning of austerity should set off alarm bells. These developments signal a turn to deflationary, contractionary folly in the major Western countries. The task of progressives and left wing people everywhere is to oppose this, with uncompromising rejection.

We have seen what it did to Latvia:

“Neoliberal austerity [sc. in Latvia] has created demographic losses exceeding Stalin’s deportations back in the 1940s … As government cutbacks in education, healthcare and other basic social infrastructure threaten to undercut long-term development, young people are emigrating to better their lives rather than suffer in an economy without jobs. More than 12% of the overall population (and a much larger percentage of its labour force) now works abroad. Children (what few of them there are as marriage and birth rates drop) have been left orphaned behind, prompting demographers to wonder how this small country can survive. So unless other debt-strapped European economies with populations far exceeding Latvia's 2.3 million people can find foreign labour markets to accept their workers unemployed under the new financial austerity, this exit option will not be available.”
Michael Hudson and Jeffrey Sommers, “Latvia provides no magic solution for indebted economies,” Guardian, 20 December 2010.

It is obvious that austerity Latvia-style has succeeded wonderfully, don’t you think? (see also Bill Mitchell, “When a country is wrecked by neo-liberalism,” Billy Blog, October 23rd, 2009).

The problem, unfortunately, is that one’s measure of success has to be causing depression, mass unemployment, 12% of the whole population working abroad, a brain drain, falling birth rates, and mass poverty.

I say in response: God damn that — and God damn neoliberalism.

The most extreme neoclassicals — and please don’t doubt that they exist — would impose this on us. They would demand much the same policies that were pursued by Weimar Germany from 1931 onwards. We must remember that it was not hyperinflation that turned Germany into the arms of a genuine lunatic: it was deflationary depression. And, while that historical episode might have been an extreme case, its lessons should not be forgotten.

Neoclassical economics is all based on totally flawed, dangerous and incompetent macroeconomics, and moral bankruptcy. Its policy prescription is domestic wage and price deflation and (in real terms) economic contraction. In a word: depression.

Welcome to the new cross of gold. Coming to an economy near you.

LAST UPDATED: 7 March.