Alesina’s ‘expansionary austerity’ — a tale of scientific delusion

27 May, 2019 at 09:27 | Posted in Economics | 4 Comments

aaustAlberto Alesina has returned to the debate on budget deficits, austerity, and growth … Now, with fellow economists Carlo Favero and Francesco Giavazzi, Alesina has written a new book entitled Austerity: When It Works and When It Doesn’t

New book, old tune. The authors’ conclusion, in a nutshell, is that “in certain cases the direct output cost of spending cuts is more than compensated for by increases in other components of aggregate demand.” The implication is that austerity – cutting the budget deficit, not expanding it – may well be the right policy in a recession …

Alesina’s theory rests on two conceptual pillars. The main one is that if deficits persist, businesses and consumers will expect higher taxes and will therefore invest and consume less … The second, supplementary pillar is the assumption that rising public debt leads investors to expect a default …

This supplementary case cannot be regarded as a general rule. If a country has its own central bank and issues its own currency, the government can cause interest rates to be whatever it wants them to be by ordering the central bank to print money. In this case, low interest rates will be the result not of austerity, but rather of monetary expansion …

So we are left with Alesina’s main pillar: a credible commitment to public spending cuts today will boost output by removing the expectation of higher taxes tomorrow.

Robert Skidelsky

As we all know there has been an obsession with government budget deficits since the crisis of 2008. Alesina’s ideas — mostly building, as apostrophised by Skidelsky, on non-convincing econometric alchemy — about austerity expansion basically boils down to the hope that if you cut deficits, the confidence fairy will make business people invest.

No matter how much confidence you have in the policies pursued by authorities nowadays, it cannot turn bad austerity policies into good job creating policies. Austerity measures and overzealous and simple-minded fixation on monetary measures and inflation ​are not what it takes to get our limping economies out of their present-day​ limbo. austerity22The austerity delusion simply do not get us out of the ‘magneto trouble’ — and neither does budget deficit discussions where economists and politicians seem to think that cutting government budgets would help us out of recessions and slumps. In a situation where monetary policies have​ become more and more decrepit, the solution is not fiscal austerity, but fiscal expansion!

We are not going to get out of the present economic doldrums as long as we continue to be obsessed with the insane idea that austerity is the universal medicine. When an economy is already hanging on the ropes, you can’t just cut government spendings. Cutting government expenditures reduces​ aggregate demand. Lower aggregate demand means lower tax revenues. Lower tax revenues mean​ increased deficits — and calls for even more austerity. And so on, and so on …

Economists have a tendency to get enthralled by their own theories and models, and forget that behind the figures and abstractions there is a real world with real people. Real people that have to pay dearly for fundamentally flawed doctrines and recommendations.

4 Comments

  1. “. . . businesses and consumers will expect higher taxes and will therefore invest and consume less . . .”
    .
    The flip side of a shortfall in aggregate demand is an unsatisfied demand for financial savings vehicles. The money the government borrows from businesses and households to finance its deficit spending is being spent in that instance on the government’s promises of future taxes and spending (in equal measure) in the form of marketable notes and bonds.
    .
    Whether the purchase of bonds and notes by households and businesses (or more plausibly by the banks making up the payments system) actually serves to reduce rates of household or business spending on goods is a question of circumstantial fact in the present moment concerning only the present.
    .
    In the act of purchasing the government’s bonds and notes, businesses, households and banks are acquiring in the present financial paper exactly equal in nominal present value to the future taxes that they can anticipate will be necessary to finance the promised payments by the government. Their expectations anticipating future taxes entailed by these financings are completely and exactly satisfied by these purchases in the present.
    .
    What must be ascertained factually in the present moment is whether the exchange of cash for bonds has any effect on present rates of spending for goods.
    .
    The intimation that anyone in the present must reduce present rates of consumption in anticipation of future taxes is entirely spurious storytelling. Future taxes will be satisfied with pieces of financial paper, pieces of paper that have been printed and taken in hand now.

    • Alberto Alesina’s argument, to be valid, requires the identification of some kind of conservation law, that is a constraint that enforces an either-or choice on agents. In other words, he ought to have a ready and specific answer to the rather obvious question: in what respect and circumstance does government spending borrowed money preclude private households or businesses from spending on goods?
      .
      His apparent answer — that businesses and households reduce consumption in anticipation of future taxes is completely stupid. 1.) Reducing spending on goods in the present does nothing to enhance the ability to pay future taxes.
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      2.) If households and businesses exchange cash for the government bonds offered, they have secured the paper necessary to pay the future taxes that will finance the promises of interest and redemption embodied in the bonds.
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      One candidate for a constraint that creates the either-or choice also known as an opportunity cost would be the aggregate production capacity of the economy. If factor resources available for production are fully utilized, then additional spending on goods by the state will crowd out spending on goods by private entities. Duh. Alesina does not want to go there, because then the argument becomes a straightforward factual matter for or against Keynesian policy, answerable in factual terms in an assessment of present circumstances.
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      Is there a conceivable circumstance in which a reduction of government purchases and borrowing could make room for latent private demand for goods for consumption and investment, and an expansion of business activity? Of course. At the end of a period of high government spending and borrowing — say, at the end of a war — when forced savings and deferred private consumption has loaded the private sector with both unsatisfied needs and the money to make those needs into effective demand, one can well imagine that “austerity” would be appropriate, even in response to the apparently low rates of resource utilization that might be associated with transitioning capacity from war uses to private consumption uses.
      .
      The facts of present circumstances matter. Abstract consideration of an essentially unknowable future is just a distraction; the future can decide for itself when it happens and a properly structured policy of state finance in the present will do nothing to constrain their choices (though, of course, a failure to take an opportunity in the present to make necessary public investment and provision may diminish the prospects of our posterity).
      .
      It would help if economists were less idiotic.

  2. […] Cross-posted from Syll’s blog […]

  3. Alessina’s book sound as if it should be read.
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    I would imagine there will be heterodox economists trawling thru the data and the statistics to see if he screwed up again.


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