Daily commentary: thoughts on austerity as a policy tool and on India as a black swan
The news flow today is about the same as it has been throughout the week: JPMorgan Chase and Facebook in the US and Greece and to a lesser degree now Spain in the EU. I think these are the wrong narratives to be focused on. As I wrote yesterday, I believe China will suffer a hard landing but that India will be worse than China. In my view, the economic slowdown in India is the biggest story that’s not making headlines.
Then there is the debate over austerity. I posted on how we had the same debates about austerity under the gold standard while Hoover was President in the US during the Great Depression (see Hoover on austerity to balance the budget and defend the dollar in 1932). Here’s my view on that debate.
I think Rajan is mostly right when he writes in the FT link on sensible Keynesians below:
the past build-up of debt in now depressed areas may suggest that demand was too high relative to incomes. If so, demand, without the dangerous stimulant of borrowing, will stay weak. Policy should instead help workers move where there are suitable jobs – for instance, by helping them offload their homes and the associated debt without the stigma of default.
As I wrote in the comment section on the Hoover post, I think it’s important to get the historical facts right instead of biasing them through an ideological lens. The Great Depression offers good lessons on this score.
The fact is Hoover was not talking austerity in 1930 and 1931. His budgets for 1930 and 1931 did not have large deficits. Once the bank crisis hit, the 1932 budget was catastrophic and that’s when the austerity rhetoric started. But in the end, he capitulated and as the crisis deepened, we never heard the austerity talk again. Hoover did not veto the spending. He signed off on it.
The right narrative on the Great Depression is that the depression was the result of significant malinvestment that was built up during the 1920s as a result of loose monetary policy at the Fed (see here), much as Rajan argues this malaise has similar antecedents in excess private sector credit growth. The question in the 1930s was how to eliminate the malinvestment and reallocate capital investment to useful productive enterprises without creating a deflationary spiral. When credit is written down, GDP drops and people are thrown out of work. That can be mitigated. It was bank runs that created the deflationary spiral that caused a Great Depression. So the answer is to write down assets and recapitalise the banking system quickly rather than dragging it out.
In the context of bank runs, attempts at austerity made things considerably worse. Austerity is a failed paradigm. The government shouldn’t have wasteful programs to begin with so there should be no need to cut them just to cut a deficit. Moreover, the deficit is the result of an ex-post accounting identity between private savings, and current account and government balances. It makes zero sense to target the effect (deficits) instead of the cause (excess credit growth and malinvestment).
I support targeted stimulus to counteract the fall in demand associated with this downturn. But it is no panacea. Until we have reduced the private indebtedness associated with the credit binge, the economy will be weak. Attempts to revive credit growth will only make matters worse.