Monday, July 18, 2011

The Austerity Delusion

According to the International Monetary Fund, via "The Economist":
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In a recent study of 173 fiscal-policy changes in rich countries from 1978 to 2009, economists from the IMF found that cutting a country’s budget deficit by 1% of GDP typically reduces real output by about two-thirds of a percentage point and raises the unemployment rate by one-third of a percentage point...

Whenever investors seek shelter, even from an American slowdown, they choose Treasuries, and thus the dollar. In an economy constrained by low interest rates, a stubborn trade deficit and natural demand for the world’s reserve currency, there is little to cushion the blow of austerity...

America cannot wait forever to rein in its debt. It needs to lay out credible plans for medium-term deficit reduction. But it has more leeway to delay cuts than most other countries, thanks to continued demand for its debt. Another year of recovery would help confidence more than a premature swing of the fiscal axe. 

(Link thanks to Mark Thoma - Economist's View.)

No confidence in the "business confidence" hype

One hears a lot about "business confidence" as the key to recovery.

Here's how the argument goes: Businesses are so worried about any increases in future taxes or possible rises in interest rates (both of which are now very, very low relative to recent history) and  about deficits (which have increased dramatically in the past two years solely because of the downturn itself, but are otherwise due primarily to tax cuts and unfunded initiatives of the Bush administration) that they are refusing to invest.  Restoring "confidence" is key to unlocking investment.

The "confidence" argument underlies the Beltway obsession that "fixing" deficits need be the current central priority - as opposed to focusing first and foremost on finding ways of quickly getting people back to work, even if it means more government spending and putting deficits aside until we are experiencing significant recovery and a steep drop in unemployment.

The reality that undermines any case for the "confidence" fixation is that business profits among the major companies are currently at record highs. Further, economist Brad DeLong offers a chart that shows businesses ARE investing and that "confidence" is not an issue, at least if investment  in capital equipment and software is a relevant measure.