If politicians fear the fiscal cliff, why do they promote austerity?by Tom Streithorst / December 14, 2012 / Leave a comment
What will happen if the Republicans and Democrats don’t reach an agreement on the fiscal cliff? According to a recent poll, almost half of Americans think the US budget deficit will rise. Actually, it is the other way around. Without an agreement, mandated spending cuts will be enacted and existing payroll tax cuts will expire; this significant deficit reduction will probably plunge America back into recession. That is why we should have adopted Paul Krugman’s preferred nomenclature and called it the “austerity bomb.”
For that’s what it is: an unnecessary and pernicious explosion that will stun America’s fragile growth. If austerity were what the economy needs, we would all be happy to let the economy drive over the fiscal cliff. Instead, politicians on both sides rightly fear it. This reveals not only that continued austerity is harmful but, more interestingly, that we all know it. After all, our current economic travails are caused by a lack of demand. If consumers are nervous about spending, then firms will continue to shed workers, making consumers even more wary of opening their wallets. This is the textbook moment for the Keynesian solution of allowing increased government deficits to spur spending, thereby kick-starting the private sector.
So why do politicians from George Osborne in the UK to Alan Simpson and Erskine Bowles in the US keep banging on about the deficit? The answer can be found in an article by the brilliant Izabella Kaminska. She looked back at the New York Times archive from the 1930s and found the same desire for austerity and fear of government spending that we suffer from today. We now know that continued austerity made the Great Depression much worse—it was only the massive spending to fund the second world war that ended the Depression.
Since John Stuart Mill in the nineteenth century, economists have reconciled Say’s law, which says that all income should be spent, with the existence of recessions by noting that sometimes holders of cash don’t want to spend it on everyday consumption or investment in capital goods but rather on safe financial assets (such as bonds) with which to secure their future. This means that the flip side…