Austerity v. economic growth

[maryland native]

I am confused on a substantial economic issue.

If my Mastercard is maxed out, my mortgage is due, I need to go to the grocery store, and I have the rest of the bills in life, I need to make changes.

I need to start eating Raman noodles, stop going to the movies, etc.

When we are looking at challenging economic times for a nation, I am hearing that austerity measures are bad, and that they will inhibit economic growth, which is counter to getting out of bad times.

This seems counter intuitive, so I am looking for some insight in how this works.

I have a friend in Estonia. She tells me that that country has some strange economic issues. It has the Euro for currency, so that can be subject to the whims of other countries, it has instituted strong austerity measures, but it still has a high unemployment rate. Very confusing.

If severe austerity is NOT good, is some good? If so, where is the balance point? How can we figure out the combination of economic things that will be most beneficial for us? Is that a trial and error method? Are there some benchmarks we need to meet?

Economics is such an odd science where it seems that all of life's normal answers, those that work for a personal finance plan, go down a rabbit hole when applied to nations.

Please help me understand the balance that must be met.

I am a new member of Democratic Underground, so please understand if I missed an explanation earlier.

You DU ers have so much knowledge to share. I am looking forward to learning!

[gollygee]

1. If you are interested

here are a few blog posts:

http://robertreich.org/post/41395861898
http://robertreich.org/post/39656182596

Here's an article:
http://www.businessinsider.com/imf-admitted-their-economists-were-wrong-2013-1

Paul Krugman has a lot to say too, if you want to go through his blog (though there's a lot to go through to find something relevant to your question):
http://krugman.blogs.nytimes.com/

[maryland native]

2. Great people

Those DU folks. My education is starting.... just like that!

I eagerly await the rest of the lessons!

[gollygee]

3. Here's another article I'd forgotten

http://www.newyorker.com/online/blogs/comment/2012/12/austerity-economics-doesnt-work.html

With all the theatrics going on in Washington, you might well have missed the most important political and economic news of the week: an official confirmation from the United Kingdom that austerity policies don’t work.
In making his annual Autumn Statement to the House of Commons on Wednesday, George Osborne, the Chancellor of the Exchequer, was forced to admit that his government has failed to meet a series of targets it set for itself back in June of 2010, when it slashed the budgets of various government departments by up to thirty per cent. Back then, Osborne said that his austerity policies would cut his country’s budget deficit to zero within four years, enable Britain to begin relieving itself of its public debt, and generate healthy economic growth. None of these things have happened. Britain’s deficit remains stubbornly high, its people have been suffering through a double-dip recession, and many observers now expect the country to lose its “AAA” credit rating.
One of the frustrations of economics is that it is hard to carry out scientific experiments and prove things beyond reasonable doubt. But not in this case. Thanks to Osborne’s stubborn refusal to change course—“Turning back would be a disaster,” he told Parliament—what has been happening in Britain amounts to a “natural experiment” to test the efficacy of austerity economics. For the sixty-odd million inhabitants of the U.K., living through it hasn’t been a pleasant experience—no university institutional-review board would have allowed this kind of brutal human experimentation. But from a historical and scientific perspective, it is an invaluable case study.
At every stage of the experiment, critics (myself included) have warned that Osborne’s austerity policies would prove self-defeating. Any decent economics textbook will tell you that, other things being equal, cutting government spending causes the economy’s overall output to fall, tax revenues to decrease, and spending on benefits to increase. Almost invariably, the end result is slower growth (or a recession) and high budget deficits. Osborne, relying on arguments about restoring the confidence of investors and businessmen that his forebears at the U.K. Treasury used during the early nineteen-thirties against Keynes, insisted (and continues to insist) otherwise, but he has been proven wrong.


Read more: http://www.newyorker.com/online/blogs/comment/2012/12/austerity-economics-doesnt-work.html#ixzz2J5zLbF7P

[KurtNYC]

4. Economics is often like an Escher drawing -- if you look at parts of it

they make sense but when you look at the whole thing it is impossible.

There is a boom and bust cycle to capitalism and to investments. It is a game used to flush money out of the hands of all the little people. They tell you to buy a house in 2006 or 2007 because "the market is great and you better buy now before prices go even higher." Banks give loans to everyone, then they say "whoops" and wipe away trillions in value. Next they buy back (or repo) what they sold so they can do it all over again.

That is the phase we are in now. "Austerity" is a marketing word, a program for the rich to buy public assets on the cheap.

[maryland native]

7. Escher drawing

Wow, that is a fantastic analogy.

Permission to use it??

[coalition_unwilling]

12. The OP's question is actually focussed around macro-economics (the study

of larger economic systems). As such, the general macroeconomic equation is useful to cut through all the bullshit and propaganda:

GDP = C + B + G + (X-I)

where

GDP = Gross Domestic Product
C = Personal Consumption
B = Business Investing
G = Government Expenditures
X = Exports
I = Imports

If C and B decline and society wishes to maintain GDP at the same level, then of necessity either G must increase (or exports increase their margin over imports).

Austerity thus is bad because it is often prescribed at exactly the moment when it is most harmful. IOW, when C and B are already in decline, the last thing that should happen is austerity (meaning cutting G or government spending). Instead, when C and B are in decline, G should increase concomitantly (if society wishes to maintain a given level of GDP).

[gollygee]

5. OK one more

http://bonddad.blogspot.com/2012/04/why-austerity-doesnt-work.html?m=1

Why Austerity Doesn't Work
From Krugman:
For the past two years most policy makers in Europe and many politicians and pundits in America have been in thrall to a destructive economic doctrine. According to this doctrine, governments should respond to a severely depressed economy not the way the textbooks say they should — by spending more to offset falling private demand — but with fiscal austerity, slashing spending in an effort to balance their budgets.

Critics warned from the beginning that austerity in the face of depression would only make that depression worse. But the “austerians” insisted that the reverse would happen. Why? Confidence! “Confidence-inspiring policies will foster and not hamper economic recovery,” declared Jean-Claude Trichet, the former president of the European Central Bank — a claim echoed by Republicans in Congress here. Or as I put it way back when, the idea was that the confidence fairy would come in and reward policy makers for their fiscal virtue.

The good news is that many influential people are finally admitting that the confidence fairy was a myth. The bad news is that despite this admission there seems to be little prospect of a near-term course change either in Europe or here in America, where we never fully embraced the doctrine, but have, nonetheless, had de facto austerity in the form of huge spending and employment cuts at the state and local level.

...

None of this should come as news, since the failure of austerity policies to deliver as promised has long been obvious. Yet European leaders spent years in denial, insisting that their policies would start working any day now, and celebrating supposed triumphs on the flimsiest of evidence. Notably, the long-suffering (literally) Irish have been hailed as a success story not once but twice, in early 2010 and again in the fall of 2011. Each time the supposed success turned out to be a mirage; three years into its austerity program, Ireland has yet to show any sign of real recovery from a slump that has driven the unemployment rate to almost 15 percent

(Click on the link and read the whole thing - it goes into detail about why austerity doesn't work.)

[Blecht]

6. You said it all right here

Economics is such an odd science where it seems that all of life's normal answers, those that work for a personal finance plan, go down a rabbit hole when applied to nations.

That's exactly right -- and that's why it's silly to directly compare the family budget to nations.

There is only one fact you need to know about national monetary policy: AUSTERITY IS CONTRACTIONARY POLICY

The consequences of reducing the money supply when people are out of work are dire. Anybody who advocates for austerity at any time other than in the middle of an economic boom falls into three main categories:

1. They are ignorant about economics.
2. They are not very smart.
3. They are vile, sadistic bastards.

It seems that almost all our leaders fall into one of these three categories.

[gollygee]

8. You're right

People like easy answers. They get simplistic about stuff. "We're spending more than we're making, so we should spend less." It's simplistic so it makes sense to them. But it is much more complicated than a household budget.

I think I'd add a 4 to yours, though you might include it under 3. But I'd add people who are predatory and are hoping to capitalize on the situation.

[Blecht]

10. They would make up a separate category

The predators might not care if their actions destroy others, so it wouldn't be right to call them sadistic.

[Recursion]

9. The short version: the Government is not a household

Eurozone countries aren't really comparable because each country doesn't control its money supply. The US does control its money supply (the Federal Reserve decides how many US dollars exist in the world).

The point of austerity is that it reduces spending, and when spending is reduced you can reduce borrowing, and when borrowing is reduced your future interest payments are decreased. By itself, that's a good thing. But austerity also decreases the GDP (that's the total amount of economic activity in the country) because those firefighters you laid off now can't afford to buy a new car or go to the movies, so car dealers and movie theater owners get less money. By itself, that's a bad thing.

[unblock]

11. the household/government analogy doesn't work because the structures are different.

a household budget is simply the sum total of the incomes and expenses of the family members.
ok, you might have an allowance for the kids, so in a sense they have their own individual budgets, but that's pretty trivial.
really, there is simply one budget for the entire house.

with government, the country as a whole (the sum total of the incomes and expenses of all the households in the country) is a very different thing from the government's budget.

in fact, the government's budget is usually the opposite of the country's budget in the sense that taxes help the government's budget but hurt households, and government spending hurt's the government's budget but helps households.

so the governments that feel the need for austerity are trying to solve a government budget problem at the expense of the country's well-being.

in the short-term, the government's budget can act as a shock absorber for the country. run a deficit to help households when the country needs it, and run a surplus when the country can afford it. this works great in most cases.

the only problem comes in when government debt, for any reason, gets to be too large in relation to the country's gdp. this may be for running deficits that were too large too long, or from failure to run surpluses when times were good, but it doesn't really matter. eventually too much government debt can cause problems.

mostly you can tell when there's too much debt when the government's cost of funds starts going up and up. so greece's government certainly has had a problem and it is evident in its borrowing costs.

at that point, the government should generally try to raise taxes and/or reduce spending, assuming the country can handle it. when times are good, this is not a problem.

there's no simple, across-the-board answer to how to solve a problem when there's too much government debt AND the country can't handle government cut-backs. but generally speaking, government austerity when the country's economy is weak is often self-defeating because it creates a vicious cycle of a worse economy, which means even more government spending and even less government revenue, which only makes the problem worse.

the flip side is for the government to stimulate to get the economy going despite the budget problems. this if done properly, the economy can then better support getting the government's budget back in order. the only trick is that the economy has to come back before the government's finances collapse altogether.

if a country has its own currency, the currency can simply devalue, which stimulates the local economy and makes the government's debt easier to repay. that's not so much an option for eurozone countries such as estonia as long as there remain stronger countries such as germany preventing the euro from devaluing enough to really help countries like estonia.

the eurozone countries have some really challenges given their unique arrangement of a central currency without central control of policy. but other countries (such as the usa) don't face those concerns. usually, a devaluation of the currency goes a long was toward solving the problems.

[upi402]

13. Austerity has failed

But just the little people. The wealthy will be fine.

I wonder if our "leaders" will ignore history and reality. Or is it the desired model for them?