This is Austerity?

Paul Krugman says,

Look first at total government spending — federal, state and local. Adjusted for population growth and inflation, such spending has recently been falling at a rate not seen since the demobilization that followed the Korean War.

Is this possible? Don Boudreaux says no, but he doesn’t really make his case because he only adjusts total government spending for inflation, not for population growth. Boudreaux points out that the spending decrease is only in relation to the spending increases of recent years, and is still more spending than in the pre-recession years. But Krugman, I presume, would see that as an irrelevant argument, since he thinks still more spending is what is necessary. That is, I doubt Krugman thinks pre-recession spending is a meaningful benchmark when you’re still trying to recover from a recession, so I doubt Boudreaux’s critique is on-point there.

But neither of them actually tells us how fast spending fell after the Korean War. Notably, the source he uses doesn’t provide total spending changes for the years following the Korean War, but only gives us 1950 and 1960. So where does Krugman get his data on total government spending following the war? He may have a source, but he doesn’t share it in his article, not even by vague allusion. That means there’s no way for anyone to verify his claims, and that’s unsettling.

Nor does either one say what where the economic effects of post Korean-war spending decline. Here’s the GDP of the U.S. from 19549 to 1955 (the Korean War ran from mid 1950 to mid 1953). The middle column shows GDP in billions of current dollars, while the right column shows GDP in 2005 dollars (source: BEA).

1949…..267.2…….1,843.10
1950….. 293.7….. 2,004.20
1951….. 339.3…… 2,159.30
1952….. 358.3…… 2,242.00
1953….. 379.3…… 2,345.20
1954….. 380.4….. 2,330.40
1955…… 414.7….. 2,498.2

In constant (nominal) dollars, there was actually a small increase in GDP from 1953 to 1954, but the inflation-adjusted dollars show a small decrease, just over a half percent. That’s not a huge decrease in GDP, especially when you consider the growth the next year, over 7% (9% in constant dollars).

What are we supposed to be worried about? According to Krugman,

Over all, the picture for America in 2012 bears a stunning resemblance to the great mistake of 1937, when F.D.R. prematurely slashed spending, sending the U.S. economy — which had actually been recovering fairly fast until that point — into the second leg of the Great Depression.

There are, of course, competing theories. Some argue that the Court’s switch to upholding the New Deal regulation in the 1937 case of West Coast Hotel v. Parrish severely damaged investor confidence, which had–so the argument goes–improved after much of the early New Deal legislation was struck down. And the monetarists point to changes in banking laws that increased reserve requirements, taking money out of the economy. But of course Krugman’s considered position is that fiscal policy is the key. But he doesn’t really make the case in this opinion that the post-Korean spending reductions were that significant, or that the spending cuts going on now really resemble 1937 that closely.

Update: Krugman provides a perhaps useful graph here. He repeats his claim that we haven’t seen this level of spending cuts since the demobilization after the Korean War, but the late 1960s decline is clearly bigger than today’s. And of course it’s still not clear what the significance of the comparison to the 1950s is, since that decline didn’t seem to have much economic effect. I have a vague impression this is something like saying, “I haven’t had that much to drink since my last communion!”
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About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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23 Responses to This is Austerity?

  1. pierrecorneille says:

    I don’t have much to add, especially because I’m ignorant about economics and about the Roosevelt Recession. I should say that I have some sympathy for the regime uncertainty theory arising from the West Coast Hotel decision. But I an suspicious of arguments that posit that that decision and the resulting uncertainty could, by themselves, depress the economy as much as it was in 1937. But I could be wrong, including about my claim that anybody actually makes the argument in a monocausal way.

  2. James Hanley says:

    I could be wrong, but I’m under the impression that all three groups tend to make their argument in monocausal ways. At least the ones that make the arguments the loudest.

  3. Troublesome Frog says:

    As you know, I am not so sympathetic to the “regime uncertainty” argument as it tends to be an ex-post explanation that pops up whenever it’s needed. One can always find a government action to explain a recession, but unless your model can adequately explain major interventions that didn’t have the same effect (Medicare Part D?), it seems to me to be all too convenient.

    Anyway, there’s a simple model I try to keep in mind whenever the “austerity” argument crops up. Let’s say the world is full of grasshoppers and ants. The ants run individual surpluses and the grasshoppers run individual deficits. That is, each ant spends less than he produces and each grasshopper spends more than he produces.

    In a world with one grasshopper and one ant, the ant’s income is the grasshopper’s spending and vice versa. Likewise, the grasshopper’s debt is the ant’s asset. For the grasshopper to pay off his debt to the ant, he must start spending less than he earns. In order for that to happen, the ant must start spending more than he earns–something not really in his nature, especially in times of crisis. This holds true for multiple grasshoppers and ants–you just need to group them together.

    People seem to realize that you can draw a bubble around taxes / government expenditures and model it as a bunch of grasshoppers. But they seem to miss the implication: Not everybody can become ants at the same time. Massive deleveraging is a hard coordination problem. The idea of everybody running a surplus at the same time appeals to our work ethic and morals about “right” living, but anybody who sees it as a solution to a financial crisis is in for disappointment.

    As for Krugman’s source, I suspect you can find it in FRED. Super cool tool. That’s where practially all of his graphs come from. I’ll see if I can dig it up.

  4. pierrecorneille says:

    I could be wrong, but I’m under the impression that all three groups tend to make their argument in monocausal ways. At least the ones that make the arguments the loudest.

    You could very well be right. I’m suspicious of most monocausal claims about what happens in the economy. I have especial reservations about the regime uncertainty hypothesis. My reservations have more to do with how one proves the hypothesis than with the hypothesis itself.

  5. Matty says:

    On regime uncertainty, is it the *uncertainty* that is the issue? only I sometimes get the impression (not here) that the term is used as a way of claiming investors share my policy preferences so they stop investing when the government does the wrong thing politically.

  6. pierrecorneille says:

    Matty,

    I also think that after West Coast Hotel, Jones Laughlin, and Wickard, there was little uncertainty: the new deal programs and similar programs at the state level would endure. They were now upheld. So businesses now knew what devil (or angel, ymmv) they were working with. And for what it’s worth, certain business interests had a lot to gain from the labor peace / control over labor that Jones Laughlin ratified, and from the agricultural quotas upheld by Wickard. Maybe the gains were something like “monopoly rents,” but the policy, once affirmed, was “certain.”

    One might say, “well, with these decisions, business persons didn’t know what the government might do next.” I’d suggest that by 1937-1938, it was pretty clear that the New Deal was moriibund, with FDR’s failed court packing plan and his failed attempt to “purge” recalcitrant southern Democrats.

    Admittedly, the prospect of World War probably created some uncertainty, and although later government initiatives are probably more accurately described as elaborations and codifications of prior new deal reforms (e.g., Taft-Hartley in large part codified much of what the NLRB had decided, at least according to historian Christopher Tomlins), one couldn’t know for sure that future presidents wouldn’t do more with the precedents they were given by the 1930s jurisprudence.

  7. Matty says:

    Now I’m confused “the new deal programs and similar programs at the state level would endure.” but “by 1937-1938, it was pretty clear that the New Deal was moribund”. Was the New Deal an enduring change in economic policy or something that died out by 1938?

  8. pierrecorneille says:

    Yikes! I was unclear (not an unusual thing for me, but still…)

    What I meant was, that new “New Deal” initiatives would not be implemented, and FDR’s power to get his way on new legislation was sharply curtailed by 1937-1938 (despite the enactment of the FLSA in 1938). What had been passed would remain, however.

    So “moribund” was a poor choice of words, to put it mildly.

  9. Matty says:

    OK so the situation was existing regulation were not going away but major new ones were not expected, right?

    If so I can’t see there was much to be uncertain about at least above the background uncertainty that is there all the time.

  10. Troublesome Frog says:

    Matty,

    That’s OK. Go over other contemporary legislation and court decisions that might conceivably have caused uncertainty. I’m sure you’ll find one. The hypothesis lives!

  11. pierrecorneille says:

    “OK so the situation was existing regulation were not going away but major new ones were not expected, right?”

    Yes.

    “If so I can’t see there was much to be uncertain about at least above the background uncertainty that is there all the time.”

    I agree. I think that’s especially true if you compare the 1937-1941 U.S. with the 1933-1937 U.S. (WWII puts a pretty big wrench in my theory, of course).

  12. lancifer666 says:

    Matty,

    On regime uncertainty, is it the *uncertainty* that is the issue? only I sometimes get the impression (not here) that the term is used as a way of claiming investors share my policy preferences so they stop investing when the government does the wrong thing politically.

    Yeah, I have always suspected this was the motivation for these types of arguments.

    “If you just implement the policies I favor, then the market will open the flood gates to reward you.”

  13. Troublesome Frog says:

    James Hanley:

    Krugman provides a perhaps useful graph here. He repeats his claim that we haven’t seen this level of spending cuts since the demobilization after the Korean War, but the late 1960s decline is clearly bigger than today’s.

    Not so. Take a look at the veritcal axis–it’s percent change year on year. You’re looking at the wrong derivative.

    I was just about to generate the same graph using the same tool. FRED is the bomb. It’s like Willy Wonka’s factory for economists. Candy cain trees and a chocolate river.

    And of course it’s still not clear what the significance of the comparison to the 1950s is, since that decline didn’t seem to have much economic effect.

    Well, the decline pretty well correlates with a short recession (aruge causation either way all you want), but I think the bigger point is that the idea that we’re somehow boosting per capita government spending is kind of silly when it has been 60 years since the last time it dropped at this rate.

    I don’t think we’re even at a point where we can argue theory and philosphy. There seems to be a crowd insisting on its own set of facts.

  14. Matty says:

    This is OT but this is also the place I think I’m most likely to find an intelligent answer. Recently the Bank of England has tried to help economic growth by providing funds to banks to increase lending to small business and households, I heard a government minister on the radio explain that this had to be done because the treasury could not spend money on the issue directly due to the importance of tackling the national debt.

    My question is, is there anything in economic theory to support the idea that getting into debt is bad for nations but good for private actors? It just doesn’t sound right to me and indeed sounds suspiciously like trying to move the debt burden on to someone else.

  15. Lance says:

    Matty,

    I haven’t seen hide nor hair of our host since my wife and I bid him, and his lovely family, adieu at the banks of Sugar Creek after a canoeing and camping adventure in Turkey Run State Park here in Indiana.

    They may still be enjoying an extended holiday.

  16. Troublesome Frog says:

    My question is, is there anything in economic theory to support the idea that getting into debt is bad for nations but good for private actors?

    No, not that I’m aware of. The sudden calls for government austerity are not usually based on any clear economic reasoning as far as I have seen. It’s more of an appeal to the behavior that most households engage in–the economy is bad so we all need to stop spending and pay off debt as quickly as we can. It’s intuition over analysis, and it’s easy to sell because it appeals to our emotions. Debt is bad and debtors are bad people. Economic crises are caused by debt. Therefore, we must do penance for our debt by making jarring changes to our public spending and tax policy.

    Of course, we can’t all simultaneously “not spend” our way to a growing economy. And, as the grasshopper and ant toy model shows, we can’t all simultaneously become savers. So when the government (or any sufficiently large group of borrowers) suddenly tries to go hard over into surplus, economic contraction is more or less necessary unless the central bank can step in and cushion the sudden change in demand for money.

    At the moment, England is sort of the poster child for having its head up its ass. The central bank is cautious about doing anything and the government is jamming the economy into a double-dip recession. And David Cameron thinks that his plan is working great while the economy contracts.

    OK everybody, you don’t have to believe that stimulus works. But can’t we all at least agree that government-led economic contraction is still economic contraction?

  17. Matty says:

    It’s more of an appeal to the behavior that most households engage in–the economy is bad so we all need to stop spending and pay off debt as quickly as we can.

    This is the core of my problem with the approach of cutting government spending while relying on bank lending to boost the economy. It is effectively saying the government should act like a prudent household but actual households shouldn’t.

  18. James Hanley says:

    is there anything in economic theory to support the idea that getting into debt is bad for nations but good for private actors?

    Not that I’ve heard. But mutatis mutandis, I don’t think there’s really much to support the idea that private debt is bad while public debt is good.It’s really a matter of how much debt you take on, and what type.

    My problem with our current situation–both in government and households–is that we seem to have gotten into the current mess in large part through excessive debt, so I’m unclear how further increasing that debt, either public or private, can actually be a good thing.

  19. Troublesome Frog says:

    James Hanely:

    Krugman and Eggertsson have a model here. It attempts to answer your question. It’s a more rigorous version of the simple grasshoper and ant model above. Basically, the level of debt doesn’t matter. The composition of debt is where the problems arise. If some entities can take on debt and, in doing so, allow certain constrained debtors to reduce their debt, it can fix certain types of problems.

    I think it’s very important to understand the implications of the simple grasshopper/ant model before rushing in and saying that we need to rapidly change the composition of the debt one way or another by a few trillion dollars.

  20. James Hanley says:

    Thanks for the link. I’m chewing that over and looking at some of the commentary on it. I do think that public debt and household debt are not identical. But off the top of my head, I’m troubled by several things. First is their argument that total debt doesn’t matter. I think it has to–if government indebtedness is low, it should have room to relieve private debt, but if government indebtedness is high, that’s going to be more difficult. Second, there’s still the question of where the relief comes from. Eggertsson and Krugman talk about both monetary and fiscal implications: monetary relief make sense to me, because it’s new money, not borrowed or taxed from anyone. But with fiscal policy there’s still the issue of where the money comes from, and what economic loss that entails. Third, the model is a one-shot game, and doesn’t address the expectations debt-relief creates. If, when I get in a bind, my debt is relieved, what lesson do i take to guide my future actions? Even accepting that the model is correct and this approach can hasten the end of a recession, it seems to enhance the prospects for future recessions, and future need for debt relief which again enhances the prospects for future recessions. That’s why I wonder if it’s not better to just suffer with a painfully slow recovery now, rather than create further economic moral hazard.

    That last bit is my real underlying concern. Does debt relief deal with the real underlying problem, or does it just treat (temporarily) a symptom?

  21. Troublesome Frog says:

    First is their argument that total debt doesn’t matter. I think it has to–if government indebtedness is low, it should have room to relieve private debt, but if government indebtedness is high, that’s going to be more difficult.

    You’re right, but you’re getting into composition. At that point, the government is one of the constrained entities. Right now, the government is substantially less constrained than the “stuck” borrowers on the private side.

    But with fiscal policy there’s still the issue of where the money comes from, and what economic loss that entails.

    The money is still borrowed. Back to the grasshopper and the ant. The crisis hits and the grasshoppers have to stop borrowing and pay of their debt. In order for this to happen, the ants must “dissave” in order to make the accounts balance. But the ants don’t want to do that in this time of crisis. It’s not in their nature, and it’s especially unlikely now. The ants still want to produce more than they consume and loan the money to a reliable borrower somewhere.

    If we bring in a third party with good credit, he can borrow the ants’ money and give the ants the safe paper they’re looking for. He can then spend the money on things produced by the grasshopper sector, allowing the grasshoppers to start paying back their debt. Call him government or call him an aggressive business with the ability to start spending hundreds of billions of dollars. Either one works.

    Normally, people shift from grasshopper state to ant state and back over their lifecycles and this whole operation happens smoothly. But if everybody tries to be an ant at once, something must happen to get the system unstuck. New money works. Third parties creating new debt and spending works. Everybody simultaneously decrying the evils of debt and cutting their spending doesn’t.

    Third, the model is a one-shot game, and doesn’t address the expectations debt-relief creates. If, when I get in a bind, my debt is relieved, what lesson do i take to guide my future actions?

    We’re not talking about writing you a check to make your debt go away. We’re talking about keeping economic activity going so that you have a job that allows you to pay off your debt. So I’m really not seeing where moral hazard creeps in.

    That’s why I wonder if it’s not better to just suffer with a painfully slow recovery now, rather than create further economic moral hazard.

    Even if I thought there was a good reason to believe that was the case, I think I’d have a hard time making that call from my comfortably employed, double-income white collar household. The cost of this chronic unemployment has been terrible, and I’m increasingly convinced that it’s largely optional.

    Ben Bernanke has basically said, “We could do more, but we’re really not concerned about the unemployment situation” more than once. That terrifies me. Even more terrifying is that the political trend seems to be for government to do the opposite of what I described above.

    Our leaders really seem to believe that we can all simultaneously become ants at the drop of a hat, and our failure to do so is a moral failing rather than simple arithmetic. Likewise in Europe, if every nation could just become a net exporter like their governments seem to think they should, everything would be fine. Wake me when that happens.

    On a semi-related note, I’ve been reading a lot of Scott Sumner over the past several months. The man is a top shelf econ blogger. I’m still trying to get my head around the mechanics of the GDP futures market, but I’m convinced that he’s probably right.

  22. James Hanley says:

    We’re not talking about writing you a check to make your debt go away. We’re talking about keeping economic activity going so that you have a job that allows you to pay off your debt. So I’m really not seeing where moral hazard creeps in.

    Reducing the consequences of misdeeds creates moral hazard. It may also be just sometimes, but that doesn’t mean it doesn’t create moral hazard.

    Even if I thought there was a good reason to believe that was the case, I think I’d have a hard time making that call from my comfortably employed, double-income white collar household.

    Of course. But if it’s correct, somebody needs to make that call, and who is going to do it except someone who’s comfortable?

    I agree about Sumner. I wonder if he’s not overselling his “it’s all about the money supply, always, and never anything else” argument, as I’m a bit suspicious of simple one-variable answers. He seems a bit monomaniacal at times, which is often the sign of a crank. But looking at the past, monetary theory’s seemed to work a lot better than fiscal policy overall, which is why I’m more inclined to believe him than the neo-Keynesians.

  23. Troublesome Frog says:

    Reducing the consequences of misdeeds creates moral hazard. It may also be just sometimes, but that doesn’t mean it doesn’t create moral hazard.

    By that definition, any monetary policy creates moral hazard. I suppose it does, but that also makes the definition of the term a litle less useful. It has fewer predictable consequences. The underlying assumption seems to be that having debt when a crisis hits is a misdeed that should be punished and this somehow makes us better off in the long run. I don’t see why this should be the case.

    Our unemployment rate is several percentage points above normal. I’d argue people who loan money or take on debt assuming a roughly historically normal economic conditions are perfectly good actors. The mistake wasn’t in engaging in normal economic activity based on historical norms. The mistake (if one can call it that) was everybody simultaneously wanting to cut spending and save. And that’s not a “mistake” on an individual level. It’s the rational and right thing to do if you expect a crisis. It just also happens to be a self-fulfilling prophecy.

    If there’s a “right” way to tweak the payoff matrix to avoid bad behavior, we’d want to create incentives that prevent sudden drops in aggregate demand rather than punishing people from taking part in normal commerce. That’s why I find Sumner’s framing of monetary policy interesting. We could get things started again by punishing the ants after the fact by threatening them with inflation. Or we could set up a regime in which there is less incentive to participate in jarring drops in AD.

    The current payoff matrix is pretty clear. If you smell trouble, you could go on as normal and risk getting screwed. Odds are against this making you rich, but it could make you poor. Or you could become an ant for a while and see what happens. This protects you from losing your shirt and the only cost is the opportunity cost of what you were planning to spend on–not very high given that you smell trouble. If we could change those incentives, we might be able to avoid these problems in the first place.

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