HowtheCaseforAusterityHas

Crumbled
PaulKrugman

JUNE6,2013ISSUE

TheAlchemists:ThreeCentralBankersandaWorldonFire
byNeilIrwin
Penguin,430pp.,$29.95
Austerity:TheHistoryofaDangerousIdea
byMarkBlyth
OxfordUniversityPress,288pp.,$24.95
TheGreatDeformation:TheCorruptionofCapitalisminAmerica
byDavidA.Stockman
PublicAffairs,742pp.,$35.00

Innormaltimes,anarithmeticmistakeinaneconomics
PresidentBarackObama PeteSouza/WhiteHouse
andRepresentativePaul
paperwouldbeacompletenoneventasfarasthewider
Ryanatabipartisanmeetingonhealth
worldwasconcerned.ButinApril2013,thediscovery
insurancereform,Washington,D.C.,
ofsuchamistakeactually,acodingerrorina
February2010
spreadsheet,coupledwithseveralotherflawsinthe
analysisnotonlybecamethetalkoftheeconomicsprofession,butmadeheadlines.Looking
back,wemightevenconcludethatitchangedthecourseofpolicy.
Why?Becausethepaperinquestion,GrowthinaTimeofDebt,bytheHarvardeconomists
CarmenReinhartandKennethRogoff,hadacquiredtouchstonestatusinthedebateover
economicpolicy.Eversincethepaperwasfirstcirculated,austeriansadvocatesoffiscal
austerity,ofimmediatesharpcutsingovernmentspendinghadciteditsallegedfindingsto
defendtheirpositionandattacktheircritics.Againandagain,suggestionsthat,asJohn
MaynardKeynesonceargued,theboom,nottheslump,istherighttimeforausteritythat
cutsshouldwaituntileconomieswerestrongerweremetwithdeclarationsthatReinhartand
Rogoffhadshownthatwaitingwouldbedisastrous,thateconomiesfalloffacliffonce
governmentdebtexceeds90percentofGDP.
Indeed,ReinhartRogoffmayhavehadmoreimmediateinfluenceonpublicdebatethanany
previouspaperinthehistoryofeconomics.The90percentclaimwascitedasthedecisive
argumentforausteritybyfiguresrangingfromPaulRyan,theformervicepresidential
candidatewhochairstheHousebudgetcommittee,toOlliRehn,thetopeconomicofficialatthe
EuropeanCommission,totheeditorialboardofTheWashingtonPost.Sotherevelationthatthe
supposed90percentthresholdwasanartifactofprogrammingmistakes,dataomissions,and
peculiarstatisticaltechniquessuddenlymadearemarkablenumberofprominentpeoplelook

foolish.
Therealmystery,however,waswhyReinhartRogoffwasevertakenseriously,letalone
canonized,inthefirstplace.Rightfromthebeginning,criticsraisedstrongconcernsaboutthe
papersmethodologyandconclusions,concernsthatshouldhavebeenenoughtogiveeveryone
pause.Moreover,ReinhartRogoffwasactuallythesecondexampleofapaperseizedonas
decisiveevidenceinfavorofausterityeconomics,onlytofallapartoncarefulscrutiny.Much
thesamethinghappened,albeitlessspectacularly,afterausteriansbecameinfatuatedwitha
paperbyAlbertoAlesinaandSilviaArdagnapurportingtoshowthatslashinggovernment
spendingwouldhavelittleadverseimpactoneconomicgrowthandmightevenbe
expansionary.Surelythatexperienceshouldhaveinspiredsomecaution.

Sowhywasnttheremorecaution?Theanswer,asdocumentedbysomeofthebooksreviewed
hereandunintentionallyillustratedbyothers,liesinbothpoliticsandpsychology:thecasefor
austeritywasandisonethatmanypowerfulpeoplewanttobelieve,leadingthemtoseizeon
anythingthatlookslikeajustification.Illtalkaboutthatwilltobelievelaterinthisarticle.
First,however,itsusefultotracetherecenthistoryofausteritybothasadoctrineandasa
policyexperiment.

1.
Inthebeginningwasthebubble.Therehavebeenmany,manybooksabouttheexcessesofthe
boomyearsinfact,toomanybooks.Foraswellsee,theurgetodwellontheluriddetailsof
theboom,ratherthantryingtounderstandthedynamicsoftheslump,isarecurrentproblemfor
economicsandeconomicpolicy.Fornow,sufficeittosaythatbythebeginningof2008both
AmericaandEuropewerepoisedforafall.Theyhadbecomeexcessivelydependentonan
overheatedhousingmarket,theirhouseholdsweretoodeepindebt,theirfinancialsectorswere
undercapitalizedandoverextended.
Allthatwasneededtocollapsethesehousesofcardswassomekindofadverseshock,andin
theendtheimplosionofUSsubprimebasedsecuritiesdidthedeed.Bythefallof2008the

housingbubblesonbothsidesoftheAtlantichadburst,andthewholeNorthAtlanticeconomy
wascaughtupindeleveraging,aprocessinwhichmanydebtorstryorareforcedtopay
downtheirdebtsatthesametime.
Whyisthisaproblem?Becauseofinterdependence:yourspendingismyincome,andmy
spendingisyourincome.Ifbothofustrytoreduceourdebtbyslashingspending,bothofour
incomesplungeandplungingincomescanactuallymakeourindebtednessworseevenasthey
alsoproducemassunemployment.
Studentsofeconomichistorywatchedtheprocessunfoldingin2008and2009withacold
shiverofrecognition,becauseitwasveryobviouslythesamekindofprocessthatbroughton
theGreatDepression.Indeed,earlyin2009theeconomichistoriansBarryEichengreenand
KevinORourkeproducedshockingchartsshowingthatthefirstyearofthe20082009slump
intradeandindustrialproductionwasfullycomparabletothefirstyearofthegreatglobal
slumpfrom1929to1933.
SowasasecondGreatDepressionabouttounfold?Thegoodnewswasthatwehad,orthought
wehad,severalbigadvantagesoverourgrandfathers,helpingtolimitthedamage.Someof
theseadvantageswere,youmightsay,structural,builtintothewaymoderneconomiesoperate,
andrequiringnospecialactiononthepartofpolicymakers.Otherswereintellectual:surelywe
hadlearnedsomethingsincethe1930s,andwouldnotrepeatourgrandfatherspolicymistakes.
Onthestructuralside,probablythebiggestadvantageoverthe1930swasthewaytaxesand
socialinsuranceprogramsbothmuchbiggerthantheywerein1929actedasautomatic
stabilizers.Wagesmightfall,butoverallincomedidntfallinproportion,bothbecausetax
collectionsplungedandbecausegovernmentcheckscontinuedtoflowforSocialSecurity,
Medicare,unemploymentbenefits,andmore.Ineffect,theexistenceofthemodernwelfare
stateputafloorontotalspending,andthereforepreventedtheeconomysdownwardspiralfrom
goingtoofar.
Ontheintellectualside,modernpolicymakersknewthehistoryoftheGreatDepressionasa
cautionarytalesome,includingBenBernanke,hadactuallybeenmajorDepressionscholarsin
theirpreviouslives.TheyhadlearnedfromMiltonFriedmanthefollyoflettingbankruns
collapsethefinancialsystemandthedesirabilityoffloodingtheeconomywithmoneyintimes
ofpanic.TheyhadlearnedfromJohnMaynardKeynesthatunderdepressionconditions
governmentspendingcanbeaneffectivewaytocreatejobs.TheyhadlearnedfromFDRs
disastrousturntowardausterityin1937thatabandoningmonetaryandfiscalstimulustoosoon
canbeaverybigmistake.
Asaresult,wheretheonsetoftheGreatDepressionwasaccompaniedbypoliciesthat
intensifiedtheslumpinterestratehikesinanattempttoholdontogoldreserves,spending
cutsinanattempttobalancebudgets2008and2009werecharacterizedbyexpansionary
monetaryandfiscalpolicies,especiallyintheUnitedStates,wheretheFederalReservenotonly
slashedinterestrates,butsteppedintothemarketstobuyeverythingfromcommercialpaperto

longtermgovernmentdebt,whiletheObamaadministrationpushedthroughan$800billion
programoftaxcutsandspendingincreases.Europeanactionswerelessdramaticbutonthe
otherhand,Europesstrongerwelfarestatesarguablyreducedtheneedfordeliberatestimulus.
Now,someeconomists(myselfincluded)warnedfromthebeginningthatthesemonetaryand
fiscalactions,althoughwelcome,weretoosmallgiventheseverityoftheeconomicshock.
Indeed,bytheendof2009itwasclearthatalthoughthesituationhadstabilized,theeconomic
crisiswasdeeperthanpolicymakershadacknowledged,andlikelytoprovemorepersistentthan
theyhadimagined.Soonemighthaveexpectedasecondroundofstimulustodealwiththe
economicshortfall.
Whatactuallyhappened,however,wasasuddenreversal.

2.
NeilIrwinsTheAlchemistsgivesusatimeandaplaceatwhichthemajoradvancedcountries
abruptlypivotedfromstimulustoausterity.ThetimewasearlyFebruary2010theplace,
somewhatbizarrely,wastheremoteCanadianArcticsettlementofIqaluit,wheretheGroupof
Sevenfinanceministersheldoneoftheirregularlyscheduledsummits.Sometimes(often)such
summitsarelittlemorethanceremonialoccasions,andtherewasplentyofceremonyatthisone
too,includingrawsealmeatservedatthelastdinner(theforeignvisitorsalldeclined).Butthis
timesomethingsubstantivehappened.IntheisolationoftheCanadianwilderness,Irwin
writes,theleadersoftheworldeconomycollectivelyagreedthattheirgreatchallengehad
shifted.Theeconomyseemedtobehealingitwastimeforthemtoturntheirattentionaway
fromboostinggrowth.Nomorestimulus.

Howdecisivewastheturninpolicy?Figure1,whichistakenfromtheIMFsmostrecent
WorldEconomicOutlook,showshowrealgovernmentspendingbehavedinthiscrisis
comparedwithpreviousrecessionsinthefigure,yearzeroistheyearbeforeglobalrecession
(2008inthecurrentslump),andspendingiscomparedwithitslevelinthatbaseyear.Whatyou
seeisthatthewidespreadbeliefthatweareexperiencingrunawaygovernmentspendingisfalse
onthecontrary,afterabriefsurgein2009,governmentspendingbeganfallinginboth
EuropeandtheUnitedStates,andisnowwellbelowitsnormaltrend.Theturntoausteritywas
veryreal,andquitelarge.
Onthefaceofit,thiswasaverystrangeturnforpolicytotake.Standardtextbookeconomics
saysthatslashinggovernmentspendingreducesoveralldemand,whichleadsinturntoreduced
outputandemployment.Thismaybeadesirablethingiftheeconomyisoverheatingand
inflationisrisingalternatively,theadverseeffectsofreducedgovernmentspendingcanbe
offset.Centralbanks(theFed,theEuropeanCentralBank,ortheircounterpartselsewhere)can
cutinterestrates,inducingmoreprivatespending.However,neitheroftheseconditionsapplied
inearly2010,orforthatmatterapplynow.Themajoradvancedeconomieswereandaredeeply

depressed,withnohintofinflationarypressure.Meanwhile,shortterminterestrates,whichare
moreorlessunderthecentralbankscontrol,arenearzero,leavinglittleroomformonetary
policytooffsetreducedgovernmentspending.SoEconomics101wouldseemtosaythatallthe
austerityweveseenisverypremature,thatitshouldwaituntiltheeconomyisstronger.
Thequestion,then,iswhyeconomicleadersweresoreadytothrowthetextbookoutthe
window.
Oneansweristhatmanyofthemneverbelievedinthattextbookstuffinthefirstplace.The
GermanpoliticalandintellectualestablishmenthasneverhadmuchuseforKeynesian
economicsneitherhasmuchoftheRepublicanPartyintheUnitedStates.Intheheatofan
acuteeconomiccrisisasintheautumnof2008andthewinterof2009thesedissenting
voicescouldtosomeextentbeshouteddownbutoncethingshadcalmedtheybeganpushing
backhard.
Alargeransweristheonewellgettolater:theunderlyingpoliticalandpsychologicalreasons
whymanyinfluentialfigureshatethenotionsofdeficitspendingandeasymoney.Again,once
thecrisisbecamelessacute,therewasmoreroomtoindulgeinthesesentiments.
Inadditiontotheseunderlyingfactors,however,weretwomorecontingentaspectsofthe
situationinearly2010:thenewcrisisinGreece,andtheappearanceofseeminglyrigorous,
highqualityeconomicresearchthatsupportedtheausterianposition.
TheGreekcrisiscameasashocktoalmosteveryone,notleastthenewGreekgovernmentthat
tookofficeinOctober2009.Theincomingleadershipknewitfacedabudgetdeficitbutitwas
onlyafterarrivingthatitlearnedthatthepreviousgovernmenthadbeencookingthebooks,and
thatboththedeficitandtheaccumulatedstockofdebtwerefarhigherthananyoneimagined.
Asthenewssankinwithinvestors,firstGreece,thenmuchofEurope,founditselfinanew
kindofcrisisonenotoffailingbanksbutoffailinggovernments,unabletoborrowonworld
markets.
Itsanillwindthatblowsnobodygood,andtheGreekcrisiswasagodsendforanti
Keynesians.TheyhadbeenwarningaboutthedangersofdeficitspendingtheGreekdebacle
seemedtoshowjusthowdangerousfiscalprofligacycanbe.Tothisday,anyonearguing
againstfiscalausterity,letalonesuggestingthatweneedanotherroundofstimulus,canexpect
tobeattackedassomeonewhowillturnAmerica(orBritain,asthecasemaybe)intoanother
Greece.
IfGreeceprovidedtheobviousrealworldcautionarytale,ReinhartandRogoffseemedto
providethemath.Theirpaperseemedtoshownotjustthatdebthurtsgrowth,butthatthereisa
threshold,asortoftriggerpoint,whendebtcrosses90percentofGDP.Gobeyondthatpoint,
theirnumberssuggested,andeconomicgrowthstalls.Greece,ofcourse,alreadyhaddebt
greaterthanthemagicnumber.Moretothepoint,majoradvancedcountries,theUnitedStates
included,wererunninglargebudgetdeficitsandclosinginonthethreshold.PutGreeceand

ReinhartRogofftogether,andthereseemedtobeacompellingcaseforasharp,immediateturn
towardausterity.
Butwouldntsuchaturntowardausterityinaneconomystilldepressedbyprivatedeleveraging
haveanimmediatenegativeimpact?Nottoworry,saidanotherremarkablyinfluentialacademic
paper,LargeChangesinFiscalPolicy:TaxesVersusSpending,byAlbertoAlesinaandSilvia
Ardagna.
OneoftheespeciallygoodthingsinMarkBlythsAusterity:TheHistoryofaDangerous
Ideaisthewayhetracestheriseandfalloftheideaofexpansionaryausterity,theproposition
thatcuttingspendingwouldactuallyleadtohigheroutput.Asheshows,thisisverymucha
propositionassociatedwithagroupofItalianeconomists(whomhedubstheBocconiboys)
whomadetheircasewithaseriesofpapersthatgrewmorestridentandlessqualifiedovertime,
culminatinginthe2009analysisbyAlesinaandArdagna.
Inessence,AlesinaandArdagnamadeafullfrontalassaultontheKeynesianpropositionthat
cuttingspendinginaweakeconomyproducesfurtherweakness.LikeReinhartandRogoff,they
marshaledhistoricalevidencetomaketheircase.AccordingtoAlesinaandArdagna,large
spendingcutsinadvancedcountrieswere,onaverage,followedbyexpansionratherthan
contraction.Thereason,theysuggested,wasthatdecisivefiscalausteritycreatedconfidencein
theprivatesector,andthisincreasedconfidencemorethanoffsetanydirectdragfromsmaller
governmentoutlays.
AsMarkBlythdocuments,thisideaspreadlikewildfire.AlesinaandArdagnamadeaspecial
presentationinApril2010totheEconomicandFinancialAffairsCounciloftheEuropean
CouncilofMinisterstheanalysisquicklymadeitswayintoofficialpronouncementsfromthe
EuropeanCommissionandtheEuropeanCentralBank.ThusinJune2010JeanClaudeTrichet,
thethenpresidentoftheECB,dismissedconcernsthatausteritymighthurtgrowth:
Asregardstheeconomy,theideathatausteritymeasurescouldtriggerstagnationis
incorrect.Infact,inthesecircumstances,everythingthathelpstoincreasethe
confidenceofhouseholds,firmsandinvestorsinthesustainabilityofpublicfinancesis
goodfortheconsolidationofgrowthandjobcreation.Ifirmlybelievethatinthecurrent
circumstancesconfidenceinspiringpolicieswillfosterandnothampereconomic
recovery,becauseconfidenceisthekeyfactortoday.
ThiswasstraightAlesinaArdagna.
Bythesummerof2010,then,afullfledgedausterityorthodoxyhadtakenshape,becoming
dominantinEuropeanpolicycirclesandinfluentialonthissideoftheAtlantic.Sohowhave
thingsgoneinthealmostthreeyearsthathavepassedsince?

3.

Clearevidenceontheeffectsofeconomicpolicyisusuallyhardtocomeby.Governments
generallychangepoliciesreluctantly,anditshardtodistinguishtheeffectsofthehalf
measurestheyundertakefromalltheotherthingsgoingonintheworld.TheObamastimulus,
forexample,wasbothtemporaryandfairlysmallcomparedwiththesizeoftheUSeconomy,
neveramountingtomuchmorethan2percentofGDP,andittookeffectinaneconomy
whipsawedbythebiggestfinancialcrisisinthreegenerations.Howmuchofwhattookplacein
20092011,goodorbad,canbeattributedtothestimulus?Nobodyreallyknows.
Theturntoausterityafter2010,however,wassodrastic,particularlyinEuropeandebtor
nations,thattheusualcautionslosemostoftheirforce.Greeceimposedspendingcutsandtax
increasesamountingto15percentofGDPIrelandandPortugalranginwitharound6percent
andunlikethehalfheartedeffortsatstimulus,thesecutsweresustainedandindeedintensified
yearafteryear.Sohowdidausterityactuallywork?

Theansweristhattheresultsweredisastrousjustaboutasonewouldhavepredictedfrom
textbookmacroeconomics.Figure2,forexample,showswhathappenedtoaselectionof
Europeannations(eachrepresentedbyadiamondshapedsymbol).Thehorizontalaxisshows
austeritymeasuresspendingcutsandtaxincreasesasashareofGDP,asestimatedbythe
InternationalMonetaryFund.TheverticalaxisshowstheactualpercentagechangeinrealGDP.
Asyoucansee,thecountriesforcedintosevereausterityexperiencedveryseveredownturns,
andthedownturnsweremoreorlessproportionaltothedegreeofausterity.
Therehavebeensomeattemptstoexplainawaytheseresults,notablyattheEuropean
Commission.ButtheIMF,lookinghardatthedata,hasnotonlyconcludedthatausterityhas
hadmajoradverseeconomiceffects,ithasissuedwhatamountstoameaculpaforhaving
underestimatedtheseadverseeffects.*
Butisthereanyalternativetoausterity?Whatabouttherisksofexcessivedebt?
Inearly2010,withtheGreekdisasterfreshineveryonesmind,therisksofexcessivedebt
seemedobviousthoserisksseemedevengreaterby2011,asIreland,Spain,Portugal,andItaly
joinedtheranksofnationshavingtopaylargeinterestratepremiums.Butafunnything
happenedtoothercountrieswithhighdebtlevels,includingJapan,theUnitedStates,and
Britain:despitelargedeficitsandrapidlyrisingdebt,theirborrowingcostsremainedverylow.
Thecrucialdifference,astheBelgianeconomistPaulDeGrauwepointedout,seemedtobe
whethercountrieshadtheirowncurrencies,andborrowedinthosecurrencies.Suchcountries
cantrunoutofmoneybecausetheycanprintitifneeded,andabsenttheriskofacashsqueeze,
advancednationsareevidentlyabletocarryquitehighlevelsofdebtwithoutcrisis.
Threeyearsaftertheturntoausterity,then,boththehopesandthefearsoftheausteriansappear
tohavebeenmisplaced.Austeritydidnotleadtoasurgeinconfidencedeficitsdidnotleadto
crisis.Butwasnttheausteritymovementgroundedinseriouseconomicresearch?Actually,it
turnedoutthatitwasnttheresearchtheausterianscitedwasdeeplyflawed.

Firsttogodownwasthenotionofexpansionaryausterity.EvenbeforetheresultsofEuropes
austerityexperimentwerein,theAlesinaArdagnapaperwasfallingapartunderscrutiny.
ResearchersattheRooseveltInstitutepointedoutthatnoneoftheallegedexamplesofausterity
leadingtoexpansionoftheeconomyactuallytookplaceinthemidstofaneconomicslump
researchersattheIMFfoundthattheAlesinaArdagnameasureoffiscalpolicyborelittle
relationshiptoactualpolicychanges.Bythemiddleof2011,Blythwrites,empiricaland
theoreticalsupportforexpansionaryausteritywasslippingaway.Slowly,withlittlefanfare,
thewholenotionthatausteritymightactuallyboosteconomiesslunkoffthepublicstage.
ReinhartRogofflastedlonger,eventhoughseriousquestionsabouttheirworkwereraisedearly
on.AsearlyasJuly2010JoshBivensandJohnIronsoftheEconomicPolicyInstitutehad
identifiedbothaclearmistakeamisinterpretationofUSdataimmediatelyafterWorldWarII
andasevereconceptualproblem.ReinhartandRogoff,astheypointedout,offeredno
evidencethatthecorrelationranfromhighdebttolowgrowthratherthantheotherwayaround,
andotherevidencesuggestedthatthelatterwasmorelikely.Butsuchcriticismshadlittle
impactforausterians,onemightsay,ReinhartRogoffwasastorytoogoodtocheck.
SotherevelationsinApril2013oftheerrorsofReinhartandRogoffcameasashock.Despite
theirpapersinfluence,ReinhartandRogoffhadnotmadetheirdatawidelyavailableand
researchersworkingwithseeminglycomparabledatahadntbeenabletoreproducetheirresults.
Finally,theymadetheirspreadsheetavailabletoThomasHerndon,agraduatestudentatthe
UniversityofMassachusetts,Amherstandhefounditveryoddindeed.Therewasoneactual
codingerror,althoughthatmadeonlyasmallcontributiontotheirconclusions.Moreimportant,
theirdatasetfailedtoincludetheexperienceofseveralAlliednationsCanada,NewZealand,
andAustraliathatemergedfromWorldWarIIwithhighdebtbutnonethelesspostedsolid
growth.Andtheyhadusedanoddweightingschemeinwhicheachepisodeofhighdebt
countedthesame,whetheritoccurredduringoneyearofbadgrowthorseventeenyearsofgood
growth.
Withouttheseerrorsandoddities,therewasstillanegativecorrelationbetweendebtandgrowth
butthiscouldbe,andprobablywas,mostlyamatteroflowgrowthleadingtohighdebt,not
theotherwayaround.Andthethresholdat90percentvanished,underminingthescarestories
beingusedtosellausterity.
Notsurprisingly,ReinhartandRogoffhavetriedtodefendtheirworkbuttheirresponseshave
beenweakatbest,evasiveatworst.Notably,theycontinuetowriteinawaythatsuggests,
withoutstatingoutright,thatdebtat90percentofGDPissomekindofthresholdatwhichbad
thingshappen.Inreality,evenifoneignorestheissueofcausalitywhetherlowgrowthcauses
highdebtortheotherwayaroundtheapparenteffectsongrowthofdebtrisingfrom,say,85
to95percentofGDParefairlysmall,anddontjustifythedebtpanicthathasbeensucha
powerfulinfluenceonpolicy.
Atthispoint,then,austerityeconomicsisinaverybadway.Itspredictionshaveprovedutterly
wrongitsfoundingacademicdocumentshaventjustlosttheircanonizedstatus,theyve

becometheobjectsofmuchridicule.ButasIvepointedout,noneofthis(exceptthatExcel
error)shouldhavecomeasasurprise:basicmacroeconomicsshouldhavetoldeveryoneto
expectwhatdid,infact,happen,andthepapersthathavenowfallenintodisreputewere
obviouslyflawedfromthestart.
Thisraisestheobviousquestion:Whydidausterityeconomicsgetsuchapowerfulgriponelite
opinioninthefirstplace?

4.
Everyonelovesamoralityplay.Forthewagesofsinisdeathisamuchmoresatisfying
messagethanShithappens.Weallwanteventstohavemeaning.
Whenappliedtomacroeconomics,thisurgetofindmoralmeaningcreatesinallofusa
predispositiontowardbelievingstoriesthatattributethepainofaslumptotheexcessesofthe
boomthatprecedesitand,perhaps,alsomakesitnaturaltoseethepainasnecessary,partof
aninevitablecleansingprocess.WhenAndrewMellontoldHerbertHoovertoletthe
Depressionrunitscourse,soastopurgetherottennessfromthesystem,hewasoffering
advicethat,howeverbaditwasaseconomics,resonatedpsychologicallywithmanypeople(and
stilldoes).
Bycontrast,Keynesianeconomicsrestsfundamentallyonthepropositionthat
macroeconomicsisntamoralityplaythatdepressionsareessentiallyatechnicalmalfunction.
AstheGreatDepressiondeepened,Keynesfamouslydeclaredthatwehavemagneto
troublei.e.,theeconomystroubleswerelikethoseofacarwithasmallbutcriticalproblem
initselectricalsystem,andthejoboftheeconomististofigureouthowtorepairthattechnical
problem.Keynessmasterwork,TheGeneralTheoryofEmployment,InterestandMoney,is
noteworthyandrevolutionaryforsayingalmostnothingaboutwhathappensineconomic
booms.PreKeynesianbusinesscycletheoristslovedtodwellontheluridexcessesthattake
placeingoodtimes,whilehavingrelativelylittletosayaboutexactlywhythesegiverisetobad
timesorwhatyoushoulddowhentheydo.Keynesreversedthispriorityalmostallhisfocus
wasonhoweconomiesstaydepressed,andwhatcanbedonetomakethemlessdepressed.
IdarguethatKeyneswasoverwhelminglyrightinhisapproach,buttheresnoquestionthat
itsanapproachmanypeoplefinddeeplyunsatisfyingasanemotionalmatter.Andsowe
shouldntfinditsurprisingthatmanypopularinterpretationsofourcurrenttroublesreturn,
whethertheauthorsknowitornot,totheinstinctive,preKeynesianstyleofdwellingonthe
excessesoftheboomratherthanonthefailuresoftheslump.
DavidStockmansTheGreatDeformationshouldbeseeninthislight.Itsanimmenselylong
rantagainstexcessesofvariouskinds,allofwhich,inStockmansvision,haveculminatedin
ourpresentcrisis.History,toStockmanseyes,isaseriesofsprees:aspreeofunsustainable
borrowing,aspreeofinterestraterepression,aspreeofdestructivefinancialengineering,

and,againandagain,amoneyprintingspree.ForinStockmansworld,alleconomicevil
stemsfromtheoriginalsinofleavingthegoldstandard.Anyprosperitywemayhavethought
wehadsince1971,whenNixonabandonedthelastlinktogold,ormaybeevensince1933,
whenFDRtookusoffgoldforthefirsttime,wasanillusiondoomedtoendintears.Andof
course,anypoliciesaimedatalleviatingthecurrentslumpwilljustmakethingsworse.
Initself,Stockmansbookisntimportant.AsidefromafewswipesatRepublicans,itconsists
basicallyofstandardgoldbugbombast.Buttheattentionthebookhasgarnered,thewaysithas
struckachordwithmanypeople,includingevensomeliberals,suggestjusthowstrongremains
theurgetoseeeconomicsasamoralityplay,threegenerationsafterKeynestriedtoshowus
thatitisnothingofthekind.
Andpowerfulofficialsarebynomeansimmunetothaturge.InTheAlchemists,NeilIrwin
analyzesthemotivesofJeanClaudeTrichet,thepresidentoftheEuropeanCentralBank,in
advocatingharshausteritypolicies:
Trichetembracedaview,especiallycommoninGermany,thatwasrootedinasortof
moralism.Greecehadspenttoomuchandtakenontoomuchdebt.Itmustcutspending
andreducedeficits.Ifitshowedadequatecourageandpoliticalresolve,marketswould
rewarditwithlowerborrowingcosts.Heputagreatdealoffaithinthepowerof
confidence.
Giventhissortofpredisposition,isitanywonderthatKeynesianeconomicsgotthrownoutthe
window,whileAlesinaArdagnaandReinhartRogoffwereinstantlycanonized?
Soistheausterianimpulseallamatterofpsychology?No,theresalsoafairbitofselfinterest
involved.Asmanyobservershavenoted,theturnawayfromfiscalandmonetarystimuluscan
beinterpreted,ifyoulike,asgivingcreditorspriorityoverworkers.Inflationandlowinterest
ratesarebadforcreditorseveniftheypromotejobcreationslashinggovernmentdeficitsinthe
faceofmassunemploymentmaydeepenadepression,butitincreasesthecertaintyof
bondholdersthattheyllberepaidinfull.IdontthinksomeonelikeTrichetwasconsciously,
cynicallyservingclassinterestsattheexpenseofoverallwelfarebutitcertainlydidnthurtthat
hissenseofeconomicmoralitydovetailedsoperfectlywiththeprioritiesofcreditors.
Itsalsoworthnotingthatwhileeconomicpolicysincethefinancialcrisislookslikeadismal
failurebymostmeasures,ithasntbeensobadforthewealthy.Profitshaverecoveredstrongly
evenasunprecedentedlongtermunemploymentpersistsstockindicesonbothsidesofthe
Atlantichavereboundedtoprecrisishighsevenasmedianincomelanguishes.Itmightbetoo
muchtosaythatthoseinthetop1percentactuallybenefitfromacontinuingdepression,but
theycertainlyarentfeelingmuchpain,andthatprobablyhassomethingtodowith
policymakerswillingnesstostaytheausteritycourse.

5.

Howcouldthishappen?Thatsthequestionmanypeoplewereaskingfouryearsagoitsstill
thequestionmanyareaskingtoday.Butthethishaschanged.
Fouryearsago,themysterywashowsuchaterriblefinancialcrisiscouldhavetakenplace,with
solittleforewarning.Theharshlessonswehadtolearninvolvedthefragilityofmodernfinance,
thefollyoftrustingbankstoregulatethemselves,andthedangersofassumingthatfancy
financialarrangementshaveeliminatedorevenreducedtheageoldproblemsofrisk.
Iwouldargue,howeverselfservingasitmaysound(Iwarnedaboutthehousingbubble,but
hadnoinklingofhowwidespreadacollapsewouldfollowwhenitburst)thatthefailureto
anticipatethecrisiswasarelativelyminorsin.Economiesarecomplicated,everchanging
entitiesitwasunderstandablethatfeweconomistsrealizedtheextenttowhichshortterm
lendingandsecuritizationofassetssuchassubprimemortgageshadrecreatedtheoldrisksthat
depositinsuranceandbankregulationwerecreatedtocontrol.
Idarguethatwhathappenednextthewaypolicymakersturnedtheirbackonpractically
everythingeconomistshadlearnedabouthowtodealwithdepressions,thewayeliteopinion
seizedonanythingthatcouldbeusedtojustifyausteritywasamuchgreatersin.Thefinancial
crisisof2008wasasurprise,andhappenedveryfastbutwevebeenstuckinaregimeofslow
growthanddesperatelyhighunemploymentforyearsnow.Andduringallthattime
policymakershavebeenignoringthelessonsoftheoryandhistory.
Itsaterriblestory,mainlybecauseoftheimmensesufferingthathasresultedfromthesepolicy
errors.Itsalsodeeplyworryingforthosewholiketobelievethatknowledgecanmakea
positivedifferenceintheworld.Totheextentthatpolicymakersandeliteopinioningeneral
havemadeuseofeconomicanalysisatall,theyhave,asthesayinggoes,donesothewaya
drunkardusesalamppost:forsupport,notillumination.Papersandeconomistswhotoldthe
elitewhatitwantedtohearwerecelebrated,despiteplentyofevidencethattheywerewrong
criticswereignored,nomatterhowoftentheygotitright.
TheReinhartRogoffdebaclehasraisedsomehopesamongthecriticsthatlogicandevidence
arefinallybeginningtomatter.Butthetruthisthatitstoosoontotellwhetherthegripof
austerityeconomicsonpolicywillrelaxsignificantlyinthefaceoftheserevelations.Fornow,
thebroadermessageofthepastfewyearsremainsjusthowlittlegoodcomesfrom
understanding.
Letters

TheDebateOverPublicDebtAugust15,2013