Why Economic Austerity Now?

by Pejman Yousefzadeh on May 6, 2012

As Garrett Jones points out, it helps demonstrate credibility, which incidentally, is good economic policy:

. . . in the 70′s, Fed officials always said they were going to fight inflation right after they got back from lunch, as Hetzel showed in his excellent history of Fed policy.  Since politicians and bureaucrats can rarely sign real contracts, the best way to prove you’ll do something later is to do it now.

Isn’t there any alternative?  Yes: The alternative is to have a great reputation as an inflation fighter — or in the fiscal realm, as a nation that eventually gets its fiscal house in order.  The U.S. and a few other countries do (did?) have such reputations, purchased in the past at a high price — purchased at the price of past tough love.  Once your politicians have built a good reputation, you can do quantitative easing without setting off inflation, you can run massive deficits without scaring bondholders.  But reputations get spent. It’s hard to say how quickly, but you can only come home late from work so often before your spouse starts wondering….

For other nations without such reputations: No such luck. Pain now is the way to show you’ll endure pain later.  Would that we had a fix for that; but the painful or humiliating initiation rituals of many social groups suggest that the problem of commitment is a persistently human one. We screen out the free-riders, the loafers, the big talkers, by making them pay the tax up front.  No need to name particular countries here.

This is why pleas for “Stimulus now, austerity later” in the U.S. and Europe have the ring of chalkboard economics: Looks great in (someone’s) theory, but out in the real world the market and the citizens see right through it.  The biggest economic problems are political: And the biggest political problem is commitment.

I think that it is entirely possible to be a fiscal austerian, while at the same time using monetary stimulus to the hilt in order to get our economic engines roaring again. We are in no danger of inflation, and of course, monetary stimulus does not add to the deficit. But in the realm of fiscal stimulus, Jones’s arguments are entirely on the mark. We always say that we are going to do something about the deficit . . . eventually. It’s time to turn “eventually” into “now.”

Past time, actually.

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