No one disputes that there are conditions under which public deficit spending leaves no impact or worse. There is therefore nothing at all controversial to Jack Ewing’s observation that “austerity and growth are not enemies.” When the private economy is humming along, unemployment is low, and consumer spending is keeping up with growth, no one to my knowledge would count austerity an enemy of growth.
What might make the statement controversial is if some group of economists—let’s call them Keynesians—believed that austerity and growth are enemies. But I would challenge anyone to find even the most diehard Keynesian economist defending such a claim.
So what gives? Here’s what gives and here is why.
Jens Weidmann, President of the Bundesbank, wants to blur the distinction between increased public spending during an economic recession and increased public spending at any time. In other words, Weidmann wants to paint all public spending, under all circumstances, with the same profligate brush. Weidmann wants to blur this distinction because, well . . . because its his job. For, unlike the United States Federal Reserve, which is statutorily obligated to maintain full employment, the Bundesbank’s statutory obligation is to maintain a strong currency.
The question is, how is the Bundesbank to maintain a strong currency during a recession? In theory, maintaining a strong currency entails withdrawing currency from circulation to match actual economic growth. So, for example, as factories close, unemployment rises, consumer spending declines, and overall economic growth shrinks, the Bundesbank has an obligation to shrink the supply of currency to match demand for that currency. In theory, if growth were to drop by 50%, then the Bundesbank would be obligated to maintain a strong currency even if it entailed maintaining depression-level unemployment and declining production.
This explains why the Bundesbank can only see one path to eliminating debt: austerity.
Why? Here is the worst case scenario that Weidmann fears. Let us assume that Greece, Portugal, Italy, France, and even the United Kingdom continue to suffer declining receipts, declining investment, decreasing consumption, decreasing industrial production and increasing unemployment. Let us assume furthermore that, largely for political reasons, the PIGS + France and UK are unable to plow ahead with their austerity plans. According to this scenario, Germany would become the sole adult in the house, responsible single-handedly for maintaining the value of the Euro, in which it currently values the debt it has purchased from other Eurozone countries. In other words, absent German austerity, the whole house collapses and, with it, the value of the Euro and the debt Germans have purchased. Germany therefore is obligated to push austerity, if for no other reason then simply because its economy is based on a strong Euro.
But this really begs the question. If European unemployment continues to rise, if investment continues to dry up, if consumer purchasing continues to flag, and if these indicators begin to eat into German production, employment, consumption, investment, and so on, then it really doesn’t matter how strong the Euro is. For in that case, we would have a strong Euro, but a weak Europe. Moreover, if this scenario actually does play out, which seems likely given Europe’s commitment to austerity, this will make it even more, not less, difficult for Germany to achieve its goal of a balanced budget by 2016.
Why? In an economy dramatically weakened by catastrophic recession, the public means for settling debt accumulated under comparatively strong economic conditions will also be dramatically reduced.
Think of it this way. Let us for the sake of argument say that the debt is € 1.5T under current conditions. Let us then take conditions under which growth is halved and the currency is also halved (in order to maintain a strong Euro, remember?). What this means is that the € 1.5T debt has effectively ballooned into a € 3T debt. Retiring this debt will then entail further austerity measures, doubling the € 3T to € 6T, and so on.
This is because debt is always relative to growth, employment, receipts, etc. Therefore, laying aside for the moment what Germany should do for the Eurozone, Germany should increase spending for its own sake, precisely in order to retire its debt by 2016.
But such are the economic blinders that Germany’s economists now wear that they anachronistically offer up precisely the opposite rationale:
Despite the worsening circumstances — which most economists schooled in the thinking of John Maynard Keynes see as a compelling reason to loosen monetary reins and increase government borrowing — German fiscal policy is already effectively set in stone. In 2009, the country adopted a constitutional “debt brake” that requires a nearly balanced national budget by 2016.
Berlin can achieve that requirement only if it starts reducing deficit spending now. Mr. Weidmann called for the government to achieve that goal sooner.
What Weidmann is calling for is nothing less than the prosaic “race to the bottom.” Germany cuts public spending. Consumer purchases decline. Production declines. Receipts decline. And now what might have otherwise been a reasonable goal seems beyond reach.
Why? Because austerity in the interest of a strong Euro has generated the very economic contraction that makes the debt balloon relative to the weakened economy.
Not only should Berlin not start reducing deficit spending now. Reducing deficit spending now will be the surest way to guarantee that the 2016 goal will not be met. If Germany wants to achieve its 2016 goal, it should instead take its lead from the U.S. Federal Reserve (rather than the U.S. Congress) and should make full employment its goal. Under conditions of near full employment and full industrial capacity, Germany’s (and Europe’s) debt crisis would quickly disappear into insignificance.
To see this, however, we need to run the above example in reverse. Let’s say that the debt is € 1.5T. Now let’s increase German industrial growth two times its current level. Now, with a demand for twice as much currency, the Bundesbank can expand its currency reserves by two, in effect halving the € 1.5T debt to €750M.
Now let’s bring the Eurozone back into the equation. Just as Germany cannot rescue its own economy by ignoring the Eurozone, so it cannot rescue its own economy if the rest of Europe insists on a course of austerity. Germany should certainly increase (or in any case not decrease) public spending for its own sake. But Germany should also encourage other Eurozone members to make full employment and full use of productive capacity their principle goals.
Thus Jack Ewing’s red herring. No one feels that austerity and growth are enemies. That is because austerity is not, in fact, an economic concept. It is a moral concept. The question is now what it has always been: how do we best distribute public goods to maximize public good? Adopting a policy of austerity with respect to the very mechanism that creates economic growth—i.e., the mechanism of employment, which drives consumption, which drives investment, which drives economic growth—might be morally satisfying, but it is economically stupid. Rather should Eurozone members identify those mechanisms that eat into and sap economic growth.
In the U.S., those mechanisms are easy to identify: un- and under-regulated financial markets, uncontrolled executive salaries, private firms that, with a few well-spent millions on a handful of politicians, can save millionaires bucketfulls of tax revenues while costing tax-paying working families the same.
Weidmann and his friends should think long and hard about where the road they are on leads. Does it lead to full employment, full production, and declining debt? Or does it lead to U.S.-style unregulated industrial and capital markets, ballooning deficits, and the destruction of the public sphere?