Where Has Austerity Helped Restore an Economy to Health?

[MediumTex]

"Austerity" programs seem to be all the rage among bankrupt governments.  When these programs are put in place, however, everyone seems surprised when they not only don't work, but actually seem to make things much worse.

Is anyone aware of a situation where austerity has restored stability to a nation's economy?

I'm not.

[moda0306]

You're fighting a losing battle with austerity to generate recovery.

One person can avoid traffic by taking the secret route, but "traffic" can't avoid traffic by taking the secret route.

Not everyone can get into the left lane to go faster.

It's so easy to visualize the paradox of thrift that I can't help but have a strong keynesian bent to my economic though, even with all of my qualms with it.

[craigr]

Neither am I.

It's like a drunk saying they are just going to go to a couple six packs a day instead of four. Usually the problem isn't resolved until they actually hit rock bottom. In the case of a country, it probably just means going broke and imploding the currency before anything changes. Even then, the changes may not always be good.

[MediumTex]

It's bizarre to me that people would accept this austerity concept as such a standard approach when it seems to fail everywhere it is tried.

Maybe austerity is sort of the economic equivalent of old-time doctors using leech therapy.  Perhaps economists of the future will look back on economic concepts like austerity and scoff at how stupid their predecessors were.

My question is why more people don't seem to notice that austerity never works...anywhere...ever.

Rather than austerity, it seems like in most cases it would be better to just default on all forms of sovereign debt and use that as a way to re-set the economy and the government's finances.  We seem to have recognized at the individual level that this can be a viable way out of financial difficulty through debt liquidation procedures such as chapter 7 bankruptcy.  I'm not sure why we don't see that governments can get into the same kind of situation as individuals and the debt can become so overwhelming that no amount of austerity could ever allow the debt to be repaid.  Rather than recognizing this early, though, governments mess around with austerity measures that tear the fabric of society apart and then the country finds itself with economic problems and political problems.

[Jan Van]

MediumTex,

your comments reminded me of this article on Naked Capitalism:

The Verboten Story of Argentina’s Post-Default Economic Success

[Lone Wolf]

"Austerity" programs seem to be all the rage among bankrupt governments.  When these programs are put in place, however, everyone seems surprised when they not only don't work, but actually seem to make things much worse.

Is anyone aware of a situation where austerity has restored stability to a nation's economy?

What's a good working definition of an "austerity" program?

The way I usually interpret this is a package of much higher taxes and reduced government expenditures.  Is this how everyone else sees it as well?  I haven't really seen this work too well.

Now, if by "austerity" you mean reduced government spending, this was very successful in combating the Depression of 1920 in the United States.  The cuts were very deep but were coupled sharp tax reductions as well.  Unemployment and debt both fell dramatically.  This isn't exactly what most people consider an "austerity program", though.

Rather than austerity, it seems like in most cases it would be better to just default on all forms of sovereign debt and use that as a way to re-set the economy and the government's finances.  We seem to have recognized at the individual level that this can be a viable way out of financial difficulty through debt liquidation procedures such as chapter 7 bankruptcy.

I almost completely agree.  The interesting exception that we can learn from, though, is that for many individuals there is still time to get themselves out of debt.  Cut back a little here, work a few extra hours, and come up with a plan and you can make it through.  When the ratio of debt to earning power is reasonable this can (and has) worked.  The same would be true for a nation if they recognize the problem before the point of no return.

In other words, control your spending.  Don't let your entitlement culture get so out of hand that it does, as you say, threaten to "destroy the fabric of society" if you so much as slow the rate of Leviathan's growth.  This is madness.

But in many cases, as you mention, the problems are so bad that the person (or the nation) really should simply declare bankruptcy and start afresh.  Greece comes to mind.

Here's the thing that I'm most curious about.  What happens after the "reset" if the culture doesn't repair itself?  If you're still left with a nation that thinks it can get endless piles of free stuff and have other people pay for it all, is even bankruptcy an escape?  It's like the shopaholic repeatedly declaring bankruptcy.  In the end, if you don't change, is "austerity" forced upon you by the laws of economics?  How would this play out for Greece?

[MediumTex]

Here's the thing that I'm most curious about.  What happens after the "reset" if the culture doesn't repair itself?  If you're still left with a nation that thinks it can get endless piles of free stuff and have other people pay for it all, is even bankruptcy an escape?  It's like the shopaholic repeatedly declaring bankruptcy.  In the end, if you don't change, is "austerity" forced upon you by the laws of economics?  How would this play out for Greece?

Greece is a great example.  How will it play out in the future for Greece?  Probably the same way it has played out in the past:

Greece has defaulted on its external sovereign debt obligations at least five previous times in the modern era (1826, 1843, 1860, 1894 and 1932). The first episode occurred in the early days of that country's war of independence, and the last default was during the Great Depression in the early 1930s. The combined length of period under which Greece was in default during the modern era totaled 90 years, or approximately 50% of the total period that the country has been independent.

LINK

[moda0306]

LW,

Could you throw out a bit more about the 1920 recession?  How bad was it?  What caused it?  How bad did unemployment get?  What was the nature/size of the tax/spending cuts and recovery?

Also, since this was post-federal reserve, did they use monetary expansion to aid the recovery?

Just wondering because the 1970's appear to be another period that would make Keynes scratch his head a bit... these time periods aren't very well analyzed by the Paul Krugmans of the world, and I don't know how to fit them into the economic debate without some perspective.

[Lone Wolf]

The combined length of period under which Greece was in default during the modern era totaled 90 years, or approximately 50% of the total period that the country has been independent.

Now that's one amusing stat!  Thanks for the historical perspective.

If for no other reason, default is an opportunity to stop lying.  Unsustainable debts are lies, and just like any lie, lead to all kinds of corrosive and unpredictable consequences.

Could you throw out a bit more about the 1920 recession?  How bad was it?  What caused it?  How bad did unemployment get?  What was the nature/size of the tax/spending cuts and recovery?

Also, since this was post-federal reserve, did they use monetary expansion to aid the recovery?

This was in large part a post-WWI slump.  Unemployment got to about 12% at the height of this depression.  The overall price level crashed by half.  It was a pretty nasty shock, actually worse initially than the beginning of the Great Depression (which, of course, ultimately got really bad.)

From what I read, government spending was reduced by about half.  I am not sure how deep the tax reductions went.  I believe that the top tax rate ended up being something like 8% (those were the days!)  I did read that the national debt was reduced by a third or so.

Also, I think that the Fed started easing toward the end of 1921, although not before the recovery was in gear.  Unemployment was already down to about 6.7% before the easing started and then down to something like 2% (2%!) by 1923.  I'd imagine that the easing fueled the later parts of the boom although I've got no insight into what degree.  I have to think that it contributed.

Thomas Woods has a nice article on this very interesting time in economic history.

[Reub]

Would Australia, Denmark, Canada, Finland and Sweden qualify?

[MediumTex]

Would Australia, Denmark, Canada, Finland and Sweden qualify?

Were those countries dealing with runaway levels of sovereign debt?

Did those countries make large cuts to government spending in the midst of a recession?

I'm just not familiar with what happened with those countries.

[TripleB]

Here's an analogy:

Suppose you have been living well beyond your means for the last 10 years. You spend 110% of what you earn. Everything you can't pay for goes on a credit card.

After 10 years, you've hit the point where the debt has snowballed so much that you can't even make the minimum payments with your salary.

You have 4 options:

1) Get a higher paying job. Let's assume you can't easily increase your salary, or you would have done it already.

2) Continue spending 110% of your salary, but being unable to make your debt payments, your creditors will cut you off in the near future.

3) Spend significantly less money, and live a considerably worse lifestyle.

4) Declare bankruptcy.

Option 1 is out already, because you'd already be doing that if you could.

Option 2 is a very short term solution that will result in either 3 or 4 very soon.

Option 3 is an "austerity" measure.

Option 4 means your credit history is destroyed for a minimum of 7 years and you will never be allowed to be an officer of a public corporation.

Option 4 doesn't mean you can easily get credit again in 7 years. It just means that the BK falls off your credit report. However, any creditor you borrowed from (i.e. Chase Bank, AMEX, etc) will blacklist you and never lend to you ever again, ever, forever. Just because the BK falls off the credit report, doesn't mean your old creditors that you defaulted on will forget about it.

Now imagine you're a country. You basically have 2 options:

Austerity or Bankruptcy

Austerity sucks. But imagine declaring Bankruptcy. You will be fucked as a country for 50+ years. How long did it take for Westerners to dissasociate Nazi-ism from Germany after WW2? A long ass time.

Countries are much like businesses. They need to spend money to make money. Need money to build infrastructure and invest in schools so you can have a productive society that can contribute to the GDP. Where does that money come from? Borrowing. What if no one will lend you money? Then no infrastructure, no police, no healthcare, no schools, and you will never grow your GDP.

Do you think Greece could declare BK tomorrow, and then next week say, "OK well now that we only owe $0, we can easily afford to make payments of a few million Euros. So lend us money again! We're good for it!" All the while, still spending the same ridiculous bullshit on generous welfare handouts to its citizens?

That's like the person living 110% beyond their means, declaring BK, but still wanting to live the same luxurious lifestyle. Would anyone lend them money again? Ever?

I left out an option above. It's Option 5: Go back to live with your parents. Admit you fucked up, ask them for help, and go live with them. In exchange, your mom gets to tell you what time to go to bed, what to eat for dinner, and she will nag you to brush your teeth. Their roof, their rules.

The sovereign equivalent is going to the World Bank. They will lend you money. But when Exxon wants to build a pipeline through your capital city, then guess what? You're tearing up your version of your "White House" to build a pipe because the World Bank is controlled by the "1%" that everyone is protesting about.

"Fuck you, World Bank! I'm not letting Exxon dig up my Capital City!"

World Bank: "Then we're not giving you you're weekly allowance that you need to pay your bond payments next week. Have fun with Austerity or Bankruptcy."

In my mind, Austerity is the best option. I may be living in a cardboard box, but I'll be damned if my mom is going to tell me what sweater to wear when I'm 50.

[Lone Wolf]

3) Spend significantly less money, and live a considerably worse lifestyle.

4) Declare bankruptcy.

I like the way you've laid it out but I wonder whether a combination of options 3 and 4 might be the best solution.

In my mind, you can only have things like a super early retirement age and a massive public sector filled with entitled perma-strikers if you are wealthy enough to afford it.  Borrowing can make you appear wealthy enough for a time but as we all know, this effect comes to an end.

The best way out for Greece, in my opinion, would be to default and reduce spending to levels that can actually be justified and paid for by actual productivity.  Their borrowing costs are going to be high if they default.  That's just the way it is.  But if they begin, immediately, to live within their means they'll be less vulnerable to these higher costs.

However, if they exit the Euro but keep running up huge deficits, they're going to be back under a mountain of debt again in no time (probably with very high interest rates.)  And if they "just print it up", they're going to look like Brazil circa 1990.

[TripleB]

So if Greece declared BK and then started austerity measures, would you lend them money? i.e. buy their bonds for your portfolio?

[Indices]

There's a fundamental misunderstanding here by some on this thread. Governments are not people. Governments are run by people. People when they lose their jobs do not print money to pay their debts. Governments however can print money to pay their debts. Unfortunately most people view a government as an entity that should be run like an individual person, i.e. the government should reduce spending when there is high unemployment. As Greece and the rest of Europe have shown, it doesn't work. It just makes things worse.

[MediumTex]

TripleB, there is a lot of good stuff in your post.  I just want to comment on a few items.

Option 4 means your credit history is destroyed for a minimum of 7 years and you will never be allowed to be an officer of a public corporation.

Option 4 doesn't mean you can easily get credit again in 7 years. It just means that the BK falls off your credit report. However, any creditor you borrowed from (i.e. Chase Bank, AMEX, etc) will blacklist you and never lend to you ever again, ever, forever. Just because the BK falls off the credit report, doesn't mean your old creditors that you defaulted on will forget about it.

I'll bet those financial institutions are happy that the American taxpayer is more forgiving of the banks' insolvency than the banks apparently are with respect to their customers' insolvency.

If the banks received the same treatment that the banks give their customers, we would have a lot fewer banks today (or maybe we would have just as many, but a lot of them would be in receivership).

Does anyone else think that it's a pretty crazy thing for a financial institution to expect the government to bail it out when it makes a bunch of stupid financial decisions (e.g., Citi, Goldman Sachs, et al), and then the financial institution turns around and tells its customer (who is in the exact same situation) that he is banned for life from ever doing business with it again because he made a stupid financial decision on a vastly smaller scale?

Austerity sucks. But imagine declaring Bankruptcy. You will be fucked as a country for 50+ years. How long did it take for Westerners to dissasociate Nazi-ism from Germany after WW2? A long ass time.

I don't know that it takes 50 years.  Nazi Germany was in a position of international prominence and Hitler was Time Magazine's Man of the Year less than 20 years after the end of World War I and the Weimar hyperinflation.

Countries are much like businesses. They need to spend money to make money. Need money to build infrastructure and invest in schools so you can have a productive society that can contribute to the GDP. Where does that money come from? Borrowing. What if no one will lend you money? Then no infrastructure, no police, no healthcare, no schools, and you will never grow your GDP.

Wouldn't you say, though, that a country is different than a business in that a business can't print money to pay its bills, while a government can?

Do you think Greece could declare BK tomorrow, and then next week say, "OK well now that we only owe $0, we can easily afford to make payments of a few million Euros. So lend us money again! We're good for it!" All the while, still spending the same ridiculous bullshit on generous welfare handouts to its citizens?

Isn't that in general what has happened in Argentina?  That country still has a lot of problems and I assume it is providing a much smaller scope of public services, but the world didn't end when it defaulted.

Similarly,here is an article describing how quickly the world started lending to Iceland again after the 2008 meltdown.

I left out an option above. It's Option 5: Go back to live with your parents. Admit you fucked up, ask them for help, and go live with them. In exchange, your mom gets to tell you what time to go to bed, what to eat for dinner, and she will nag you to brush your teeth. Their roof, their rules.

One way of looking at the euro countries is that the weaker members are already living at their German parents' house.  At first, they liked it because they felt like they had more freedom, but now it's starting to suck because they realize that their parents are the ones who get to make the rules.

World Bank: "Then we're not giving you you're weekly allowance that you need to pay your bond payments next week. Have fun with Austerity or Bankruptcy."

In my mind, Austerity is the best option. I may be living in a cardboard box, but I'll be damned if my mom is going to tell me what sweater to wear when I'm 50.

From my perspective, a country's right to control its own economy and currency is central to the whole concept of sovereignty.  It seems to me that Greece telling the rest of the EU to just kiss its ass as it goes back to the drachma would obviously include great economic hardship, but it would represent an expression of sovereignty and self-determination that would be sort of the equivalent of you and your cardboard box.

[Lone Wolf]

There's a fundamental misunderstanding here by some on this thread.
...
People when they lose their jobs do not print money to pay their debts. Governments however can print money to pay their debts.

Sure, but this is a pretty obvious point.  Everybody on this thread realizes that governments can print money to pay their bills (so long as they control their own currency.)  It's the whole reason we aren't afraid to hold government bonds in a deflation.  When money is scarce (in a deflationary depression), the government will still be able to cough it up.

The whole concept is fairly central to the PP.

So yes, you can always just "print it up".  However, some of us take a dim view of how this process unfolds in the hands of a fiscally imprudent government.  (Even the MMT \ Chartalist crowd acknowledges the grave danger of inflation when this gets out of hand.)

Remember, we don't even need to be talking about ruinous hyperinflation here (although I can envision a possible world where Greece broke from the Euro and got itself in such a jam.)  Even non-accelerating but high levels of inflation badly screw up an economy and rob citizens of their purchasing power.  But when debt gets big enough, this can become a "least bad" option when interest rates rise high enough.

[stone]

Reub, I also immediately thought of Canada 1995 as the classic example:
http://articles.businessinsider.com/201 ... t-spending
"The policy response was swift and decisive. When the fiscal tsunami finally hit in 1995 the policy makers were forced into action. Ironically the Liberal led government whose tax and spend policies had helped contribute to the crisis, passed an historic austerity budget. (They don't deserve all of the blame for causing the crisis...their Conservative predecessors were just as culpable)  In it Federal spending was cut by almost 10% over the next two years and federal employment roles were slashed by 14%. The government also committed to reform two formerly untouchable entitlement programs...welfare and the Canada Pension Plan (CPP). Over the next three years, working with the provincial governments, the CPP was reformed to include the investment of surplus contributions into equities and bonds, cut overly generous benefits and increased the contribution rate....all of the moves contributing to the future solvency of the fund.
In relative terms, the economic results were just as swift...and beneficial. By 1998 the federal government was in surplus and had reduced nearly $650bil of debt. The provincial governments had similar positive debt reduction experiences. Despite the naysayers suggesting that austerity budgets would lead to slower growth and lower employment... the exact opposite happened as the Canadian economy has thrived....which has helped to grease the skids toward meaningful tax reform. In 2001 the federal corporate income tax rate was cut and is now 18%, down from 28%....and the plan is to cut it more. From a competitive standpoint compare this to the US federal rate of 35%. Capital gains taxes have also been reduced twice to 14.5% and the national sales tax was also cut from 7 to 5%."

I think though that it is imperative to try and unpick how these "structural reforms" worked. From what I can make out, much of the effect is down to bubble blowing- sucking flows of money in from other parts of the world to buy privatized assets and partake in low capital gains tax etc. It is much harder if all countries are trying to do that simultaneously. Privatizations are claimed to improve things by causing assets to be utliized more efficiently once they are in the private sector. From what I can see much of the effect is actually just a one off capital inflow shot in the arm that is just as feckless as any boondoggle government scheme.

[stone]

The conversion of "entitlement liabilities" into government buying of stocks and bonds mentioned above is a hillarious bit of bubble blowing nonsense. Perhaps that could be done worldwide. Why not include stamps or fine art in the mix. The western world could get together and decide to "invest" all state pension liabilities into rare stamps. If you knew that the government was commited to putting several trillion dollars into rare stamps over the coming years, wouldn't you feel compeled to re-mortgage your house to invest in the new 3xSTAMP leveraged ETF?

Let's be clear about what is going on with these austerity measures around the world. The aim is to have privatization programs leading to road tolls, privatized high schools, prisons etc with the toll booth money going direct to an oligarchy who appoint a "technocratic" government to enforce these "unavoidable reforms". It is a way to support an oligarchy attaining a life of squander and self importance. The irony is that it is one way that I could actually imagine hyper-inflation taking place. Hyper-inflation is all about failure of essential supplies. A rebelion against austerity and injustice could lead to the kind of supply crisis that is a pre-requisit for classic hyperinflation.

[MediumTex]

Let's be clear about what is going on with these austerity measures around the world. The aim is to have privatization programs leading to road tolls, privatized high schools, prisons etc with the toll booth money going direct to an oligarchy who appoint a "technocratic" government to enforce these "unavoidable reforms". It is a way to support an oligarchy attaining a life of squander and self importance. The irony is that it is one way that I could actually imagine hyper-inflation taking place. Hyper-inflation is all about failure of essential supplies. A rebelion against austerity and injustice could lead to the kind of supply crisis that is a pre-requisit for classic hyperinflation.

See Naomi Klein's "The Shock Doctrine" for a comprehensive discussion of the process described above.

[stone]

This link has an article with lots of historical context and opinion about this. It also says that a debt crisis was behind the fall of Rome! :-
http://michael-hudson.com/2011/12/democracy-and-debt/
"The resulting conflict is pitting financial interests against national self-determination. The idea of an independent central bank being “the hallmark of democracy”? is a euphemism for relinquishing the most important policy decision – the ability to create money and credit – to the financial sector. Rather than leaving the policy choice to popular referendums, the rescue of banks organized by the EU and ECB now represents the largest category of rising national debt. The private bank debts taken onto government balance sheets in Ireland and Greece have been turned into taxpayer obligations. The same is true for America’s $13 trillion added since September 2008 (including $5.3 trillion in Fannie Mae and Freddie Mac bad mortgages taken onto the government’s balance sheet, and $2 trillion of Federal Reserve “cash-for-trash”? swaps).
This is being dictated by financial proxies euphemized as technocrats. Designated by creditor lobbyists, their role is to calculate just how much unemployment and depression is needed to squeeze out a surplus to pay creditors for debts now on the books. What makes this calculation self-defeating is the fact that economic shrinkage – debt deflation – makes the debt burden even more unpayable.
Neither banks nor public authorities (or mainstream academics, for that matter) calculated the economy’s realistic ability to pay – that is, to pay without shrinking the economy. Through their media and think tanks, they have convinced populations that the way to get rich most rapidly is to borrow money to buy real estate, stocks and bonds rising in price – being inflated by bank credit – and to reverse the past century’s progressive taxation of wealth.
To put matters bluntly, the result has been junk economics. Its aim is to disable public checks and balances, shifting planning power into the hands of high finance on the claim that this is more efficient than public regulation. Government planning and taxation is accused of being “the road to serfdom,”? as if “free markets”? controlled by bankers given leeway to act recklessly is not planned by special interests in ways that are oligarchic, not democratic. Governments are told to pay bailout debts taken on not to defend countries in military warfare as in times past, but to benefit the wealthiest layer of the population by shifting its losses onto taxpayers."

[Gumby]

Sure, but this is a pretty obvious point.  Everybody on this thread realizes that governments can print money to pay their bills (so long as they control their own currency.)  It's the whole reason we aren't afraid to hold government bonds in a deflation.  When money is scarce (in a deflationary depression), the government will still be able to cough it up.

The whole concept is fairly central to the PP.

So yes, you can always just "print it up".  However, some of us take a dim view of how this process unfolds in the hands of a fiscally imprudent government.  (Even the MMT \ Chartalist crowd acknowledges the grave danger of inflation when this gets out of hand.)

Of course. Everyone agrees that a government can trigger inflation if politicians do dumb things. That's true of any monetary theory. But, high inflation does not come from simply printing money. If that were so, we'd actually have high inflation right now. We don't. Inflationistas have been predicting high inflation for a decade now with our 'exploding money supply.'  So, obviously the simple "money printing = inflation" theory is flawed.

In order for inflation to take hold in a country that isn't reserve constrained — such as the US or Japan — the private sector needs to have low levels of private debt, high levels of employment, and high levels of disposable income. There is little risk of inflation as long as those are not happening.

Inflation is highly correlated with disposable income...

[align=center][/align]

Perhaps our government's wall street's solution to keeping inflation low is to make sure 99% of the population doesn't have much disposable income. In other words, as long as only 1% of the population reaps the benefits of massive spending/bailouts, there is little risk of inflation since most people will be starving for food in bread lines.

[stone]

Gumby, I guess the very worst cases of inflation come when supply totally crashes. In such a scenario even if only 1% of the population has any money, they will cough up all of that money inorder to buy essentials/passage out of the country, rather than starving. The government may then try and go into printing overdrive to pay the police etc enough to keep them OK and that will drive the spiral. I guess rationing (such as was done in the UK in the 1940s) is the only way to avoid such a scenario in the face of a supply collapse.

[moda0306]

Great graph, Gumby!  I didn't realize that it was such a nice, tight correlation.

I think it helps to envision the numerous ways government can/could make our lives miserable and choke markets without even touching monetary policy, and the effect these things can and will have on the markets, making things more expensive than they should be.  Further, outside events will have huge effects on price levels.

Is heroin expensive because of the fed or because it's illegal?

How about a human kidney on the black market?

Is the Portland housing market expensive because of the money supply, or land-use regulations?

If a terrorist sets off a nuke in Saudi Arabian oil fields, is the spike in oil prices Ben Bernanke's fault?

If we're going through dry weather in a vast area of the country, is the hike in food prices because of QEII?

I do, though, wonder what affect the mere existence of higher reserves (aka, potential legal tender in the economy) has on commodity speculators... though eventually the rubber having to hit the road (cash leaving banks) for this speculating to pay off.

[stone]

moda I guess the excess reserves can be used by the banks for ever bolder trading wildness. Even though the oil price or whatever can not sustainably  be higher than consumers can afford to pay, a "universal bank" can use those excess reserves for engineering a roller coster ride of commodity price volatility and use that for profiteering.