This article does a good job of explaining why expansionary austerity does not work. It assumes that cuts in government spending will only reduce economic output by less than one. Moreover, classical economists argue that increasing government spending will only crowd out private spending and that the expansionary multiplier is less than one. They believe that monetary policy can deal with short term issues in the business cycle and that fiscal policy is ineffective and not necessary.
Some believe that monetary policy is ineffective when interest rates are at the zero bound, as they are today in the US and in much of Europe. The private sector is saving money even at negative real interest rates. We have unused labor, and unused capital. Government should borrow to absorb the unused savings and spend it on goods and services that will increase output, and employ the idle labor and capital. In this situation there will be no crowding out, and each unit of government spending will produce more than one unit of output. In other words, the fiscal multiplier is positive during a recession. Classical theory may not apply in recessionary periods when we are the zero bound. Some may even argue that classical theory does not even work in a full employment economy. Frankly, I don't believe that micro theories do a very good job of describing the economic behavior of individuals or firms even in a full-employment economy. Therefore, attempts to use micro theory as the foundation for macro theory have not been very useful in the real world. We learn more from our study of economic history than we do from micro or macro theory. Unfortunately, few graduate programs in economics harvest the information about the real economy that is only available from the study of economic history.
The IMF just announced that it made a mistake in its assumptions about the fiscal multiplier. That is described in the post that follows. Unfortunately, much of the harm has already been done in Europe.
No comments:
Post a Comment