Austerity and stimulus in northern Europe

I want you to consider the following two northern European economies:

Country A had a deficit of 8.8% of GDP in 2011.   According to The Economist, only Egypt and Greece had larger deficits in 2011.   It has an unemployment rate of 8.2%, well above the natural rate.

Country B ran a budget surplus of 2% of GDP in 2011.  It has an unemployment rate of 7.3%, well above the natural rate.  A recent news article said the following about country B:

********** centre-right coalition government is being too tight-fisted with public finances that are likely to remain strong for years to come, a think tank charged with evaluating policy said on Monday.

The ********* Fiscal Policy Council, a state agency that evaluates government policy, said it saw little risk the country would breach spending ceiling rules in the coming years and instead urged the government to slacken spending constraints.

If you had to guess, which one would be practicing “austerity” and which one is engaged in “stimulus?”  I’m not going to tell you yet, but I’ll provide some quotations from Paul Krugman, and I want you to see if you can match them up with the respective countries:

I learn from Ezra Klein’s interview with Tom Coburn that Sweden, of all places, has become the new right-wing icon. I thought Europe’s woes were all about collapsing welfare states? But anyway, the story now is that Sweden has slashed spending and cut taxes, and is doing great; supply-side economics vindicated!

.   .   .

But Ezra didn’t challenge Coburn on the claim about spending cuts; why don’t we look at what Sweden has actually done, as opposed to the official right-wing line? Look, in particular, at actual government consumption — purchases of stuff. Here’s Sweden versus the United States, from Eurostat:

Somebody has been practicing harsh spending-side austerity — and it’s not Sweden.

OK, so Sweden’s not the mystery nation practicing austerity.  How about this one:

Jonathan Portes is angry, and rightly so. He points out that the Cameron government is systematically starving public investment:

There might conceivably be a justification for this policy if Britain were facing an intense cash squeeze. But it isn’t — it’s able to borrow very cheaply, with near-zero real interest rates even on very long-term borrowing.

And given that public investment is, you know, productive, this is almost surely a case of self-defeating austerity:

Yes, tight-fisted Britain must be country B, and socialistic Sweden must be country A.  Wrong.  Britain had the massive deficit and Sweden is running a surplus.  I might add that the data Krugman presented has absolutely no bearing on the claims made by Senator Coburn.  He claimed spending cuts were made, and of course in countries like Sweden a big part of spending is transfers, not consumption.  Kind of unfair to ridicule someone, and then provide irrelevant evidence to back up your claim.

Now I’m sure a million Krugmanites will rush over here and tell me I have the data all wrong.  And they’d be right, every source I checked had different numbers.  I have no idea whether Sweden’s spending went up or down in recent years.  (Although I do know their debt to GDP ratio is falling, while those ratios are soaring much higher in the US and UK.)  But what difference does it make?  In the world of Keynesian economics spending can soar much higher, and they’d still insist that austerity is occurring.  If the Keynesians are to be believed we have savage cuts in government spending in America, despite data showing spending levels much higher than before the recession.  You can cut the numbers anyway you want, and get whatever result you want.  One of their favorite techniques is to explain away the high government spending by pointing to the depressed state of our economies, even though most private forecasters see this as the new normal, RGDP will never recover to the old trend line in either the US or UK.

But if you are not a committed ideologue on either side, just look at the data provided up top.  Does Country A really look like savage austerity?  Does country B look like a country engaged in fiscal stimulus?

In the post on Sweden Krugman also had this to say:

Ezra points out, rightly, that Sweden has actually benefited a lot from very aggressive monetary policy — one of the original Princeton zero-lower-bound Group of Four, Lars Svensson, is now deputy governor of the Riksbank. (The others were Mike Woodford, yours truly, and a fellow by the name of Ben Bernanke).

Readers of TheMoneyIllusion were the first to find out about the Swedish monetary stimulus back in 2009.  But that begs raises another question.  Isn’t Britain also outside the euro?  If monetary stimulus makes fiscal stimulus unnecessary (and it does), then why would Britain want to do fiscal stimulus?  Why not just do monetary stimulus, and avoid the big deficits?  After all, just the other day didn’t Krugman say that there’s no argument at all for fiscal stimulus when monetary stimulus is available?  Yes he did.  And now he’s (correctly) attributing Sweden’s relative success to monetary stimulus (it sure wasn’t deficit spending!)

Some might argue that the BOE is stubborn like the Fed, they’ll refuse to raise their inflation target, or switch to NGDP targeting, and that these are the only routes to success when near the zero bound.   But wait, in Britain I thought the target was set by the government, not the BOE?  Why not instruct the BOE to set a higher inflation or NGDP target?

Just to be clear, I’m not saying there aren’t good arguments for the BOE keeping a 2% inflation target.  I don’t agree with those who support this target, but it’s an intellectually respectable argument.  But only a complete lunatic would argue that the Cameron government should refuse to boost the inflation target above 2%, but then engage in fiscal stimulus which can only work by boosting inflation! That’s like shifting your car into neutral, than flooring the accelerator. They’d have to be complete masochists; “Let’s spend lots of money, run up a huge debt, and then watch the BOE sabotage our policy.” 

PS.  Krugman acts like he just discovered the growing right-wing love affair with the Nordics.  And yet over a year ago the Heritage Foundation rated Denmark more economically free than the US.  If Krugman were smart he’d march right down to the Heritage Foundation and demand they join him in calling for Congress to scrap the US economic system and replace it with the Danish system.  I’m sure Krugman would go for that idea, but how about the Heritage Foundation?


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61 Responses to “Austerity and stimulus in northern Europe”

  1. Gravatar of Brito Brito
    17. May 2012 at 00:34

    Expectations matter, I’m annoyed that you’re not applying your own logic on central bank stance to the treasury, regardless of the actual size of the deficit, here in Britain there has been MASSIVE rhetoric and explicit announcements of heavy austerity and belt tightening to come and this would surely be the effect to dominate; people are not expecting any fiscal expansion any time soon.

    “then engage in fiscal stimulus which can only work by boosting inflation! ”

    Many many Keyensians do not regard this as true; many believe supply curves are essentially flat in this situation from excess capacity, hence a boost in AD will boost income but not inflation, in the short run. It’s the New Keynesians that regard price reflation/expectations as the be all and end all, but Krugman isn’t really a New Keyensian.

  2. Gravatar of Britmouse Britmouse
    17. May 2012 at 04:49

    “then watch the BOE sabotage our policy”

    Yesterday the BoE showed they will do exactly that: they are going to let the 2-year CPI forecast again drift below the 2% target since the nearer term forecasts will stay above 2% for longer.

    Meanwhile Cameron pleads with them to ease.

    http://uneconomical.wordpress.com/2012/05/17/david-cameron-your-country-needs-you/

  3. Gravatar of Britmouse Britmouse
    17. May 2012 at 04:57

    Also, a more open attack on inflation targeting from Wren-Lewis:

    http://mainlymacro.blogspot.co.uk/2012/05/inflation-targeting-is-not-working.html

  4. Gravatar of Wadolowski Wadolowski
    17. May 2012 at 05:00

    It’s so heart warming that 41th economist on the list

    http://ideas.repec.org/top/top.person.all.html

    writes such a praising words for NGDP targeting

    http://www.project-syndicate.org/commentary/the-death-of-inflation-targeting

    What a fine day :)

  5. Gravatar of OneEyedMan OneEyedMan
    17. May 2012 at 05:12

    Enjoyable piece and move evidence of what a mess the anti-austerity argument is.

    BTW – Begging the question is assuming what was to be proved not a synonym for raising the question.

  6. Gravatar of Frederic Mari Frederic Mari
    17. May 2012 at 05:30

    You said: “But only a complete lunatic would argue that the Cameron government should refuse to boost the inflation target above 2%, but then engage in fiscal stimulus which can only work by boosting inflation! That’s like shifting your car into neutral, than flooring the accelerator. They’d have to be complete masochists; “Let’s spend lots of money, run up a huge debt, and then watch the BOE sabotage our policy.”

    Can we get some proof of the key proposition i.e. fiscal stimulus only works because it creates inflation?

    Furthermore…

    “The May Inflation Report revealed the Bank is now expecting the economy to grow by about 0.8pc this year, and not the 1.2pc it expected in an earlier forecast. The Bank does not expect the economy to return to its pre-crisis level before 2014.

    Inflation is expected to remain above the 2pc target “for the next year or so”, signalling an ongoing squeeze on household incomes.

    The inflation forecast was in contrast to the Bank’s expectation in February that the annual rate was more likely to below target than above it by the end of the year. Annual inflation is currently 3.5pc”.

    So, will we assume everything will be fine soon in the UK? Their inflation is picking up and “real” inflation (i.e. the one suffered by middle class people) is probably even higher…

  7. Gravatar of Woj Woj
    17. May 2012 at 05:33

    Really strong argument and well presented. Krugman and many others have been redefining austerity to fit their policy proposals. The other week I noted: The Austerity Experiment Failed Without Really Starting (http://bubblesandbusts.blogspot.com/2012/05/austerity-experiment-failed-without.html).

    My favorite quote was:
    “But only a complete lunatic would argue that the Cameron government should refuse to boost the inflation target above 2%, but then engage in fiscal stimulus which can only work by boosting inflation!”

    Central banks and Treasuries continue to work against each other’s goals and the costs are becoming clearer.

  8. Gravatar of Rien Huizer Rien Huizer
    17. May 2012 at 05:38

    Scott,

    Why would the UK gvt do things that improve the economy? They want to be seen doing that, but substance is another matter. Maybe not. You do not understand politics. Pity poor BoE

  9. Gravatar of Richard A. Richard A.
    17. May 2012 at 05:53

    “But only a complete lunatic would argue that the Cameron government should refuse to boost the inflation target above 2%, but then engage in fiscal stimulus which can only work by boosting inflation! That’s like shifting your car into neutral, than flooring the accelerator.”

    It’s worse. This is like shifting your car in drive, then flooring the accelerator(fiscal policy), while keeping the brake to the floor(monetary policy). This makes the fiscal multiplier ZERO.

  10. Gravatar of Mike Sax Mike Sax
    17. May 2012 at 05:53

    I still think a budget deficit doesn’t prove there’s been no austerity. The whole point Krugman and company make is that austerity is self-defeating as it lowers tax revenues and drives up the deficit higher.

    In any case you’re argument about not doing fiscal stimulus is one thing. I never buy it but we differ there. But even if you say don’t do stimulus it’s another call entirely to say not only don’t raise spending but cut it much further.

    You say that the CB will cancel out any fiscal stimulus-this could be true of course with inflation targeting. Mind you it was not true in the pre-Volcker Fed. But by arguing for austerity-I don’t know if you’re trying to argue for austerity here or simply criticize anyone who criticizes it-isn’t that the same thing?

    Won’t asking for monetary stimulus and fiscal austerity at the same time cancel out just like fiscal stimulus and monetary tightening?

  11. Gravatar of Mike Sax Mike Sax
    17. May 2012 at 06:03

    “most private forecasters see this as the new normal, RGDP will never recover to the old trend line in either the US or UK.”

    So Tyler Cowen’s Great Stagnation is now a fait accompli? If we’re already at this new lower trend why do monetary stimulus eihter?

  12. Gravatar of Britmouse Britmouse
    17. May 2012 at 06:14

    Mike, the UK is aiming to hold fiscal spending (ignoring debt interest) roughly constant in nominal terms, and has raised taxes – mostly in VAT, and is hoping to close the deficit as tax revenue tracks upwards with with NGDP. Total tax revenue went up about 4% in the 2011-12 fiscal year, so probably about 2% faster than NGDP at basic prices (i.e. ex VAT).

    Of course, people like to deflate fiscal spending by, say, CPI and say it’s falling in real terms, so – austerity! Of course the CPI includes the VAT change, so that makes no sense.

    Measured UK government “output” even went up 1.5% in 2011 – i.e. public services are not obviously disappearing. Krugman won’t show you that graph. The “austerity” is that imposed on the private sector by low NGDP growth and tax rises.

  13. Gravatar of Peter N Peter N
    17. May 2012 at 06:16

    The UK is in a very tricky position. It’s informative to look at total debt public and private as a percent of gdp:

    uk 920%
    japan 640%
    sweden 460%
    europe 450%
    norway 430%
    US 350%
    australia 340%
    canada 290%

    This doesn’t include unfunded liabilities.

    The UK can’t afford to let NGDP fall or to increase their debt faster than NGDP. They’re in a tough situation, but their policies seem rather ill-suited to their predicament.

    I suspect their having a coalition government doesn’t help.

  14. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 06:27

    I’ve said it before, and I’ll say it again. When Sumner critiques Keynesians, he’s up there with the best of them.

    It’s too bad though that his own views are grounded in the same fundamentals as the Keynesians, which then leads him to making his own destructive recommendations (well, constructive in the short run for Wall Street and the Treasury).

    In the world of Keynesian economics spending can soar much higher, and they’d still insist that austerity is occurring.

    To be fair, market monetarists do the exact same thing. In the world of market monetarist economics inflation of the money supply can soar much higher, and they’d still insist that tightening is occurring.

    Keynesians believe “austerity” is occurring when employment remains low, no matter what the spending happens to be, and Market Monetarists believe “tightening” is occurring when NGDP remains low, no matter what the money printing happens to be.

    This is because Keynesians believe fiscal spending really does work, and Market Monetarists believe printing money really does work. If there are economic problems, then both schools believe there is not enough of what they believe works.

    Of course Market Monetarists are distinct from the Keynesians in that if they can get their 5% NGDP, then they won’t care what happens to employment or output. They will blame everything and everyone, but they will excuse monetary policy and market monetarists. The Keynesians don’t have an explicit goal like this, after which they then blame everything and everyone other than themselves. They have an unintended and implicit goal, which is total government take-over of the economy. There is nothing within Keynesianism that can serve as a critique against increasing government spending relative to GDP. If government spending is 10% of GDP, or if it’s 100% of GDP, Keynesianism can only ever recommend more government spending to solve whatever problems exist.

    Know how to make a Keynesian’s head spin? Ask them what they would say if in a world with 100% government spending to GDP (i.e. world-wide communism), where the economy has had 20% unemployment and wide-spread idle resources for decades, and an argument is made to cut government spending by 50% GDP.

    The Keynesian doctrine would have us believe that communism should remain in force, which of course is a sanction of the unemployment and idle resources!

    Don’t believe me? I can prove it by simply asking for one Keynesian to step up and show me a single case where a Keynesian economist has complained of “idle resources” owned by the state and called for more private spending on those idle resources to get them “moving”. For example, huge swaths of Nevada and Alaska land territory is owned by the state. There are also many “idle” conservation areas owned by the state. Yet we don’t see any Keynesian crying foul over THOSE “idle resources.” And why not? Because they’re owned by the state, and so these “idle resources” are tolerated. The only “idle resources” that are not tolerated are those owned by private citizens. It’s not tolerable for private citizens to own a resource and hold out from selling them. No, if that happens, then the state is called upon to spend money on those “idle resources.”

  15. Gravatar of KRG KRG
    17. May 2012 at 06:52

    You can’t tell stimulus vs austerity from single numbers; they’re about changes in public spending in response to demand for such spending, completely orthogonal to deficits or surpluses.

    Krugman’s graph can’t be used to say for sure that Sweden is engaging in stimulus or that the US is implementing austerity, only that Sweden doesn’t meet one of the baseline conditions necessary to be classified as austerity (negative spending growth), so at worst it’s employing a neutral policy. On the other hand the US’s negative spending growth makes intentional austerity a possibility as one of the causes of the decline (strong private sector growth could be also be at play, which is why the graph isn’t sufficient on its own to do anything but show that employment of austerity measures is very unlikely if it doesn’t show active spending cuts)

  16. Gravatar of ssumner ssumner
    17. May 2012 at 07:01

    Brito, Sorry, but the idea of a flat SRAS was discredited decades ago. Oil prices soar just on rumors of QE.

    But if the SRAS really was flat, then monetary stimulus would also fail to boost inflation, so Krugman’s call for higher inflation would literally make no sense. I realize their are a few dinosaurs who there who still believe in flat SRASs, but my blog isn’t aimed at that demographic.

    Britmouse, Good stuff, and thanks for that Wren-Lewis post.

    Wadolowski, Yes, I’m already working on a post.

    Thanks OneEyedman, and I fixed the grammar.

    Frederic, See my answer to Brito. Don’t confuse supply and demand side problems. Fiscal stimulus addresses demand side problems.

    Woj, Not only are the costs becoming clearer, but economists are speaking out more and more (Note Wren-Lewis and Frankel both sort of endorsing NGDP targeting today.)

    Rien, You asked:

    “Why would the UK gvt do things that improve the economy?”

    Ummm, Because they want to be re-elected? Or is this a trick question?

    Richard, Yes, a much better analogy.

    Mike Sax, Most of all I’m arguing for clear thinking. until we understand the real issues we won’t develop solutions. And given the recent surge in interest in NGDP targeting, I see no reason to stop now.

    Peter N, Good point about how weak NGDP makes the debt crisis worse, at all levels.

    MF, No fiscal stimulus is costly, monetary policy is like turning s steering wheel, no setting is more costly than any other.

  17. Gravatar of ssumner ssumner
    17. May 2012 at 07:02

    KRG, You said;

    “Krugman’s graph can’t be used to say for sure that Sweden is engaging in stimulus or that the US is implementing austerity, only that Sweden doesn’t meet one of the baseline conditions necessary to be classified as austerity (negative spending growth),”

    Wrong. Krugman’s graph tells us nothing about Swedish spending growth. Read my post again.

  18. Gravatar of KRG KRG
    17. May 2012 at 07:23

    Major_Freedom:
    “Know how to make a Keynesian’s head spin? Ask them what they would say if in a world with 100% government spending to GDP (i.e. world-wide communism), where the economy has had 20% unemployment and wide-spread idle resources for decades, and an argument is made to cut government spending by 50% GDP.”

    To accomplish what? Is there an output shortage of some sort that you’re suggesting is also at play? I mean, let’s flesh your scenario out a little bit. The society in question has perfected self-powered matter replicators that simple require four buttons to be pushed at the same time once a year to keep operating. Every year five people line up for the opportunity, and the ones that win the job get a nice ceremonial coin of thanks for their service. Most natural resources protected as a preserve, since people can get whatever they need from the replicators.

    Now someone proposes that two of the people each year should, instead come up with their own coins (by borrowing or trading for them with current coin holders; making their own would be counterfeiting), so that the private sector is picking up half the cost simply because they insist that it’s bad for the public at large to bear the costs of making 4 new coins each year.

    The proposal simply doesn’t make sense in that particular case, and it highlights exactly where you’ve left out any useful data to use to actually assess the situation with.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. May 2012 at 07:33

    @Wadolowski,

    Note also that Frankel linked approvingly to this article:

    http://www.jstor.org/discover/10.2307/2077870?uid=3739696&uid=2129&uid=2&uid=70&uid=4&uid=3739256&sid=56161527213

    @Scott,

    I’m slowly coming around to the idea there are some supply side problems in the UK so some observations:

    1) In NGDP terms the UK has done as well or better than the other major currency zones since 2008Q3 (US, eurozone, Japan).

    2) UK CPI has gone from understating inflation relative to the GDP deflator to massively overstating inflation since 2008Q3

    3) Even so, inflation as measured by the deflator has been on average higher in the UK since 2008Q3.

    Now, when I mention #1, all is relative, as the UK is still some 10% below trend. #2 makes it politically more difficult then it needs to be in raising #1. And #3 tells me there is an AS problem of mysterious origins.

    The latest thing among MMTers and Post Keynesians that I’ve observed in the blogosphere is to blame the higher inflation in the UK on monetary stimulus and fiscal austerity. Since they rarely have anything coherent to say this eventually gravitates towards ideological name calling. Yesterday I was called a Fox-watching Friedmanite (I don’t mind the Friedman so much, but Fox?!?)

    One of the things I tried to point out was that monetary austerity eventually leads to fiscal austerity. In fact I cited the contrast between Poland & Sweden versus UK & the eurozone.

    Incidentally government spending is up even more strongly in Poland than in Sweden, but not becuase of fiscal stimulus. It’s because due to adequate monetary stimulus their economy is booming in relative terms.

    But it is pointless citing empirical evidence to such ideologues. They are too busy planning the revolution.

    As the song says, “clowns to the left of me, jokers to the right….”

  20. Gravatar of dwb dwb
    17. May 2012 at 07:45

    @ Mark

    I have been wondering the same thing, I noticed that the gdp deflator (FRED) was a lot lower than the UK CPI. I have been wondering about the effect of import prices on the UK CPI. any thoughts about that?

  21. Gravatar of Frederic MARI Frederic MARI
    17. May 2012 at 08:07

    Frederic, See my answer to Brito. Don’t confuse supply and demand side problems. Fiscal stimulus addresses demand side problems.

    Right. And I thought we at least agreed that the trick in our present state was to revive AD i.e. it’s a demand side issue. Thus fiscal stimulus might well work – with some caveats.

  22. Gravatar of fernando fernando
    17. May 2012 at 08:08

    “I want you to consider the following two northern European economies:

    Country A had a deficit of 8.8% of GDP in 2011. According to The Economist, only Egypt and Greece had larger deficits in 2011. It has an unemployment rate of 8.2%, well above the natural rate.

    Country B ran a budget surplus of 2% of GDP in 2011. It has an unemployment rate of 7.3%, well above the natural rate. A recent news article said the following about country B”

    What about each countries current account?
    United kingdom

    http://sdw.ecb.europa.eu/browseChart.do?sk=118.DD.A.GB.BP_CUCA.PGDP.4F_N&type=free&node=SEARCHRESULTS&q=capital+account&trans=N

    Sweden

    http://sdw.ecb.europa.eu/browseChart.do?sk=118.DD.A.SE.BP_CUCA.PGDP.4F_N&node=SEARCHRESULTS&q=Current+and+new+capital+account+balance&type=series&trans=N

    Sweden may run a budget surplus without hurting their economy as much because the stimulus is coming from foreigners buying swedish goods and services.
    So I dont think deficit spending is a good measure of austerity, there are other factors.

  23. Gravatar of Benjamin Cole Benjamin Cole
    17. May 2012 at 08:11

    Right on.

  24. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 08:14

    ssumner:

    MF, No fiscal stimulus is costly, monetary policy is like turning s steering wheel, no setting is more costly than any other.

    You’ve been shown many times that this is not true. You’re still fallaciously treating the rate of inflation or rate of spending growth as nothing but a sterile mechanistic statistic. You’re ignoring the human element, you’re ignoring the relative spending and price changes that are brought about, and you’re ignoring the effects that changed interest rates (when the inflation takes the form of new loans) bring about.

    Inflation is NOT solely about the price level increasing, or aggregate spending increasing, such that 5% is just as sterile and benign as 2%. Inflation always enters the economy at distinct points first, and so a higher price level target, or a higher aggregate spending target, generates higher changes to relative spending and prices, particularly interest rates.

    Don’t believe me? Then explain this chart:

    http://i.imgur.com/AOHwQ.png

    Explain why, during the drop in “aggregate spending” post-2008, the construction sector suffered more than the durable goods sector, why the durable goods sector suffered more than the non-durable goods sector, why the non-durable goods sector suffered more than the retail sector, and why the retail sector suffered more than the service sector.

    I have an answer to this because I don’t just look at “aggregate spending.” I look WITHIN the aggregates and ask why would different sectors be affected differently during a period of a decline in spending. Aggregate spending cannot explain this.

    In the period prior to 2008, when aggregate spending was increasing all nice and smoothly, some sectors were affected differently than other sectors. Inflation did not affect every sector equally. The statistic “aggregate spending”, as Hayek repeatedly pointed out, masks and obfuscates the micro-level relative spending and prices, which affects the real economy, and THAT is where the problems are solidified and in need of being corrected.

    Nobody would argue that investors should embark on projects that require more physical capital than is available to complete them. Yet this is what inflation of the money supply does to investors. It makes them embark on projects that require more capital than is available. So market monetarists are essentially telling the Fed to mislead investors into starting physically unsustainable projects that future inflation cannot solve!

    This is precisely why we see in the chart a distinct pattern of declines between the sectors when “aggregate spending” falls. And wouldn’t you know it? This result is exactly what is expected in the Austrian theory, which holds that inflation does not in fact affect all industries equally in the boom phase, but expands certain sectors too far beyond other sectors, and, specifically, it affects the more capital intensive and more sensitive to interest rates sectors more than it affects the less capital intensive and less sensitive to interest rates sectors.

    If less capital was allocated to the construction and durable goods sectors, and more towards retail and service sectors, then we would not have seen so much unemployment post 2008. But investors had no way of knowing to do this, precisely because inflation mislead them!

    When you call for more inflation into the banking system now to get some silly aggregate back up to some arbitrary status quo standard, all you are doing is calling to mislead investors yet again, by making them invest in projects that cannot be completed because the real capital is lacking.

    So yes, there is in fact different costs to different levels of inflation of the money supply and aggregate spending. The higher the inflation and aggregate spending target, the higher the costs.

  25. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 08:18

    KRG:

    “Know how to make a Keynesian’s head spin? Ask them what they would say if in a world with 100% government spending to GDP (i.e. world-wide communism), where the economy has had 20% unemployment and wide-spread idle resources for decades, and an argument is made to cut government spending by 50% GDP.”

    To accomplish what? Is there an output shortage of some sort that you’re suggesting is also at play? I mean, let’s flesh your scenario out a little bit. The society in question has perfected self-powered matter replicators that simple require four buttons to be pushed at the same time once a year to keep operating. Every year five people line up for the opportunity, and the ones that win the job get a nice ceremonial coin of thanks for their service. Most natural resources protected as a preserve, since people can get whatever they need from the replicators.

    Now someone proposes that two of the people each year should, instead come up with their own coins (by borrowing or trading for them with current coin holders; making their own would be counterfeiting), so that the private sector is picking up half the cost simply because they insist that it’s bad for the public at large to bear the costs of making 4 new coins each year.

    The proposal simply doesn’t make sense in that particular case, and it highlights exactly where you’ve left out any useful data to use to actually assess the situation with.

    The proposal doesn’t make any sense = I don’t like your proposal.

    Ergo Keynesianism cannot help but defend Stalineque central planning over a 50% reduction in government spending to GDP.

    You’re just proving my point.

  26. Gravatar of Bonsoir mon cherie Bonsoir mon cherie
    17. May 2012 at 08:27

    But why is the Swedish Krona weakening so drastically against the Euro?

  27. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 08:30

    KRG:

    You can’t tell stimulus vs austerity from single numbers; they’re about changes in public spending in response to demand for such spending, completely orthogonal to deficits or surpluses.

    It isn’t true that changes in public spending are “in response” to demand for such spending. You make it sound like politicians are not self-interested and do not spend unilaterally for their own sake.

  28. Gravatar of W. Peden W. Peden
    17. May 2012 at 09:00

    It’s nice to see several arguments that you’ve been developing over the past few months come into a single, coherent and focused post. It’s like a drafting process.

    I nearly asked Vince Cable (the UK business secretary) at a Q&A after his lecture on Adam Smith in Scotland back in 2010 about whether or not he thought it was possible to combine fiscal austerity with the Bank of England’s current monetary regime. It would have been interesting to put him on the spot in a public forum. However, I was prevented by several long “questions” asked by other members of the audience, including one student who simply read a prepared written speech and raised her voice slightly at the end of it as if she was asking a question.

    It would be too extreme and absurdly delusionally arrogant to blame her for Britain’s current economic woes, but there was an intellectual incoherence in all three major UK parties’ policies even in 2010: the assumption that there was a trade-off between growth and austerity was based on the false premise that growth is purely determined by fiscal policy. As Scott Sumner had made clear even in 2010, in an inflation-targeting monetary system fiscal policy only affects growth on the supply side.

    What we needed in June 2010 was (a) the emergency budget we had AND (b) a switch to a better monetary target- my preference is now for a nominal wage target, but an NGDP target would do almost as well. Even a price level target based on a broad price index (RPI or the GDP deflator) would have been slightly better.

  29. Gravatar of Saturos Saturos
    17. May 2012 at 09:23

    But then why is Sweden’s unemployment so high? Australia’s isn’t.

  30. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 09:35

    Saturos:

    But then why is Sweden’s unemployment so high? Australia’s isn’t.

    Yes, why are there so many hangover headaches, pains, and nausea in the rehab clinics, but none at the Playboy mansion parties?

    Obviously the solution is to turn the rehab clinics into nightclubs.

  31. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. May 2012 at 09:54

    dwb,
    You wrote:
    “I have been wondering the same thing, I noticed that the gdp deflator (FRED) was a lot lower than the UK CPI. I have been wondering about the effect of import prices on the UK CPI. any thoughts about that?”

    Yes, my thoughts are along the same line. The GDP deflator of course measures inflation in all goods produced domestically whereas the CPI measures inflation in good puchased by consumers which of course includes import inflation. The pound depreciated sharply with respect to other major currencies from July 2008 through March 2009 and imports are about a third of GDP so that should explain the difference.

    One way of confirming this might be to find out if the UK has a deflator for Gross Domestic Purchases and compare that to the GDP deflator. Another would be to check their import price index (I assume they have one).

    But this still leaves the mystery as to why their GDP deflator is running relatively high. Could this be related to the devaluation as well? (I have no clue, I’m just thinking out loud.)

  32. Gravatar of Saturos Saturos
    17. May 2012 at 10:14

    I never realized Major Freedom was so familiar with the Playboy mansion…

  33. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. May 2012 at 10:15

    Steve Keen comes from Australia and naturally according to the Keensians Australia is doomed (we all are) because of its high debt level. I went to investigate this claim and the evidence is mixed:

    1) Australia ranks ninth in the overall level of private and public debt (277% of GDP) among the ten largest advanced countries.

    2) Australia is among the three countries on this list that have deleveraged the most since 2008.

    3) Australia has the highest level of household debt measured as a percent of GDP (105%) among these ten nations.

    So, #1 and #2 are good, and #3 is bad. But this is the first I’ve heard that Australia is teetering on the brink of depression.

    This information comes from this (Page 13):
    http://www.mckinsey.com/Insights/MGI/Research/Financial_Markets/Uneven_progress_on_the_path_to_growth

    which contradicts the numbers provided by Peter N above.

  34. Gravatar of dwb dwb
    17. May 2012 at 10:17

    But this still leaves the mystery as to why their GDP deflator is running relatively high.

    define “high”: based on fred, it seems to be running in the 2.3% range.

    yes, i’d love to see some sort of trade-weighted pound index, or an index of import prices.

    http://research.stlouisfed.org/fred2/graph/?g=7ig

  35. Gravatar of Mark A. Sadowski Mark A. Sadowski
    17. May 2012 at 10:34

    dwb,
    “define “high”: based on fred, it seems to be running in the 2.3% range.”

    This is what I’m thinking about:

    Average annual rate of change (%) 1998Q3-2008Q3

    Currency Area-NGDP–RGDP-GDPDeflator-CPI-Difference
    Euro-17——-4.09–2.04—2.02——2.26—0.24
    US————4.99–2.48—2.45——2.97—0.52
    Japan——-(-0.28)-1.09-(-1.35)—–0.00—1.35
    UK————4.93–2.61—2.25——1.86-(-0.39)

    Average annual rate of change (%) 2008Q3-2011Q4

    Currency Area-NGDP—-RGDP–GDPDeflator-CPI-Difference
    Euro-17——-0.57–(-0.38)—0.94——1.57—0.63
    US————1.93—-0.56—-1.38——1.12-(-0.26)
    Japan——-(-1.74)-(-0.41)-(-1.33)—(-0.87)–0.46
    UK————2.03–(-0.30)—2.34——3.15—0.81

    Note that the UK is the only major currency area that has had a higher average GDP deflator since 2008Q3.

    P.S. The graph you posted seems to show the gap between CPI and GDP deflator has opened up only recently (after the 2008-2009 devaluation), which is also puzzling. The UK is beginning to bug me with its seemingly endless inconsistencies.

  36. Gravatar of dwb dwb
    17. May 2012 at 10:44

    The UK is beginning to bug me with its seemingly endless inconsistencies.

    yeah, its an excellent question. the gap seems very large to me.

    My suggestion is that you hop on a plane and head over there and check for yourself. Stop by a few Sainsburys and Marks and Spencers and do a personal price check.

  37. Gravatar of orionorbit orionorbit
    17. May 2012 at 11:03

    Scott, I have no time to look up official numbers, but much of the Swedish “austerity” comes from the gov’t selling its stake in Nordea. So gov’t purchases are if anything a better instrument for whether the Swedish fiscal policy was contractionary or expansionary, but i’m stopping here because I can’t find the exact price for the Nordea share (should be in the tenths of billions.)

    Regarding number discrepancies, Riksbank/Statistics Sweden prevail, at least this is the convention; no idea if the data are more reliable per se.

    Also unemployment in Sweden should be interpreted differently from the UK as Swedish companies are big labor hoarders and this is more or less consensus among labor economists here.

  38. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 11:05

    Saturos:

    I never realized Major Freedom was so familiar with the Playboy mansion…

    How could you have realized it? It would be like you introducing yourself to me for the first time, and then I say “I never realized your name was [your name]!”

    Good to see the analogy either went way over your head, or the implications of it are just too uncomfortable for you to address.

  39. Gravatar of ChargerCarl ChargerCarl
    17. May 2012 at 12:41

    You said:

    “If Krugman were smart he’d march right down to the Heritage Foundation and demand they join him in calling for Congress to scrap the US economic system and replace it with the Danish system. I’m sure Krugman would go for that idea, but how about the Heritage Foundation?”

    My guess is no. They’d disown it just like they disowned the individual mandate because it was proposed by the democrats.

  40. Gravatar of BZ BZ
    17. May 2012 at 13:12

    I don’t understand the ultimate difference between fiscal and monetary stimulus — I mean, in one case the state gives borrowed or printed money to preferred groups to trickle down to the rest of us, while in the other the central bank gives borrowed or printed money to preferred groups to trickle down to the rest of us. Isn’t it all “fiscal” in a sense, with the biggest difference being who gets it first?

  41. Gravatar of orionorbit orionorbit
    17. May 2012 at 14:54

    BZ, there are many differences than fiscal and mon. stimulus.

    For one, fiscal stimulus is constrained, in the sense that the gov’t cannot spend more dollars than it can gather through taxes or debt, while monetary stimulus is not constrained as it can always print more dollars. This might seem trivial but it’s not, because when the market knows the fed is unconstrained and credible, it will respond to monetary stimulus. This is why it is always possible for a country to create inflation.

    More importantly, fiscal stimulus in a depression tends to end up “saved” to large extend. For instance if you gave $100 to each american, they’d end up saved to the extend that mortgage owners would use it to pay back their loans etc.

    Also, monetary stimulus, other things equal, leads to lower interest rates in the medium run while fiscal stimulus leads to lower interest rates in the short run (if you trust some ISLM kind of analysis) but in the medium run the interest rate will depend on whether fiscal stimulus led to inflation in which case an inflation-targeting CB will have to actually raise the interest rates.

  42. Gravatar of Jason Jason
    17. May 2012 at 16:26

    I think Krugman’s point with the graph with Sweden and the US is that if Sweden has engaged in austerity then the US has engaged in more austerity. I agree that there seem to be no firm figures out there about spending changes in Sweden (after hours of searching), but all of them are smaller than the US reductions (at all levels government).

    And if Sweden has engaged in less austerity and we have engaged in more, why aren’t we showing more benefit?

    Additionally, there is kind of a funny point to be made that Coburn would consider Swedish levels of government and taxation to be insane since he considers reverting to a 39.6% MTR from 35% to be socialism.

    All of this I think points to a general trend among conservatives (mostly, but people in general can overlook details in ideological arguments) that the direction of a policy change and the subsequent direction of change macroeconomic indicators is a meaningful result. But the size of that change is also important. Basically if tax cuts happened, and then there is economic growth, then the tax cuts caused the growth. It doesn’t matter what the size of the tax cuts were or if bigger tax cuts produced smaller results or smaller tax cuts produced bigger results.

    Or in the Swedish case here, much like the US in the 1980s, if the size of the monetary policy “force” far outweighs the size of any fiscal policy “force”. [Even if you don't subscribe to monetary completely cancelling fiscal, the relative magnitudes should point to monetary policy being dominant.]

  43. Gravatar of Saturos Saturos
    17. May 2012 at 21:21

    orionorbit, actually ISLM says fiscal stimulus raises rates in the short run, which is precisely how it works.

    BZ, monetary stimulus is increasing the money supply, which the central bank controls. Fiscal stimulus is the Treasury inducing people to hold less money, one way or another.

    When you say trickle down, it sounds like you’re talking about distributing income, which is not (directly) the purpose of such stimulus at all, instead it is to increase nominal flows of spending.

  44. Gravatar of Andrew Andrew
    18. May 2012 at 02:21

    The Bank of England has already actually let inflation stay up at 3-4% for the past two years. Now the projection is that over the next year inflation won’t come near the 2% target.

    I’ve always had the impression that internally the Bank of England has a nominal (5%) GDP target, as well as the 2% target, even if for public presentational terms they always stick to 2% (every graph shows that two years out, inflation returns to 2%. Even if they get it wrong every time).

  45. Gravatar of orionorbit orionorbit
    18. May 2012 at 03:43

    Saturos, you’re of course right, BZ please ignore that silly mistake of mine.

  46. Gravatar of Blake Blake
    18. May 2012 at 07:56

    Sweden’s debt is declining because its GDP and revenues are expanding. Their stimulus paid for itself and then some. The reason people are still complaining is because they believe that more stimulus could be doing more to address unemployment if the government wasn’t trying to please the foreign austerity-hawks and prematurely engaging in austerity now that GDP has begun growing again.

    Spending, even real total expenditures, expanded during the recession (1.18% in real terms from 2008-2009) while revenue collection fell (by 6.1% in real terms from 2008-2009). Sweden had been engaged in fiscal contraction during the good years, so they had plenty of room to do this. This led to a full recovery of the lost ground in GDP inside of two years and despite being hit by the rest of Europe’s misguided attempts at austerity they still have projected positive real GDP growth for this year.

    For data, I’ve been relying on http://epp.eurostat.ec.europa.eu/

  47. Gravatar of Bob Murphy Bob Murphy
    18. May 2012 at 08:23

    Good post, Scott. I had no idea Sweden was running a budget surplus, and I read Krugman every day. Go figure…

  48. Gravatar of Major_Freedom Major_Freedom
    18. May 2012 at 10:32

    Saturos:

    When you say trickle down, it sounds like you’re talking about distributing income, which is not (directly) the purpose of such stimulus at all, instead it is to increase nominal flows of spending.

    The purpose is subservient to the actual effects. Inflation does redistribute income, regardless if the intention is merely to increase nominal spending.

    The academics might believe the purpose is to increase nominal spending, but the only reason the power players agree to it is because of the redistribution effects. That’s why the Fed was created in the first place anyway. To enable the fractional reserve banks to create new loans out of nothing and earn interest, while having a backstop central bank to bail them out of bank runs and bankruptcies.

  49. Gravatar of ssumner ssumner
    18. May 2012 at 18:02

    Mark, All good points—I still have an open mind on the UK.

    Frederic, It seems unlikely the BOE would let it work.

    Fernando, Trade surpluses are not “stimulus.” They raise net exports but reduce investment. In any case, the key is monetary policy, which drives NGDP regardless of whether in deficit or surplus.

    Bonsoir, How much has it fallen?

    W. Peden, Yes, a wage target is optimal. But it’s a tough sell.

    dwb, Actually 2.3% seems a bit high to me, for an economy where RGDP is falling.

    orionorbit, It’s very hard to get data, because it can be measured in many ways. For instance, about 6% of GDP is simply taxed welfare benefits. So it’s equally correct to argue the Swedish government is (say) 55% or 49% of GDP. The numbers are all over the place. But the national debt has been trending downward in recent years–that’s very different from the US and UK.

    ChargerCarl, You are right.

    BZ, No the Fed doesn’t give money away.

    Jason, You said;

    “I think Krugman’s point with the graph with Sweden and the US is that if Sweden has engaged in austerity then the US has engaged in more austerity.”

    That may be his point but he’s flat out wrong. The US national debt is skyrocketing and the Swedish debt is falling. The fact that the US recession has been slightly worse doesn’t even come close to explaining that gap. It’s obvious to me that US fiscal policy is more expansionary.

    Andrew, But NGDP growth is falling well below 5% in the UK.

    Blake, Look at the ratio of the national debt to GDP in the US and Britain and Sweden over the past few years. Why didn’t the US and Britain also have robust recoveries? Didn’t Krugman praise Gordon Brown for the aggressive stimulus in 2009?

    Bob, You said;

    “I had no idea Sweden was running a budget surplus, and I read Krugman every day.”

    Hmmmm.

  50. Gravatar of Mike Sax Mike Sax
    18. May 2012 at 18:27

    “The latest thing among MMTers and Post Keynesians that I’ve observed in the blogosphere is to blame the higher inflation in the UK on monetary stimulus and fiscal austerity. Since they rarely have anything coherent to say this eventually gravitates towards ideological name calling. Yesterday I was called a Fox-watching Friedmanite (I don’t mind the Friedman so much, but Fox?!?”

    “One of the things I tried to point out was that monetary austerity eventually leads to fiscal austerity. In fact I cited the contrast between Poland & Sweden versus UK & the eurozone.”

    Mark I would call myself something of a Post Keynesian I suppose though probably not an MMTer-I like some of their ideas but the name is a little cultish for me. I’m not much of a joiner.

    I don’t think monetary stimulus causes fisca austerity but what I do notice is that many who advocate monetary stimulus seem to at the same time desire fiscal austerity.

    As far as Britain having high inflation: for my part I would like to see higher inflation in the US but Britain in that regard does show that higher inflation doesn’t necesarily mean higher growth.

    Again, notice that Cameron is about austerity and monetary stimulus. That is his formula. At this point the results are not encouraging.

  51. Gravatar of justanothereconomist justanothereconomist
    18. May 2012 at 21:06

    “I want you to consider the following two northern European economies:

    Country A had a deficit of 8.8% of GDP in 2011. According to The Economist, only Egypt and Greece had larger deficits in 2011. It has an unemployment rate of 8.2%, well above the natural rate.

    Country B ran a budget surplus of 2% of GDP in 2011. It has an unemployment rate of 7.3%, well above the natural rate. A recent news article said the following about country B:

    Yes, tight-fisted Britain must be country B, and socialistic Sweden must be country A. Wrong. ”

    This Keynesian knows that fiscal expansion leads to prosperity which raises tax revenues and reduces social spending. So it’s no surprise that Sweden is running a surplus and Britain a deficit.

    Scott- can we get you on the record that Greece is not practicing austerity? Their deficit is high, which, just like Britain. The Greek deficit is 9.1%- Greece shows how damaging Keynesianism can be, right? Ireland had the highest deficit in the Eurozone in 2001, probably due to their Keynesian policies too…..

  52. Gravatar of John Papola John Papola
    19. May 2012 at 16:05

    “This Keynesian knows that fiscal expansion leads to prosperity”

    This is why Keynesian economics is so fundamentally broken. What leads to increasing prosperity is increasing productivity that enables more goods and services that serve real needs and are produced and sold at cost-covering prices. THAT leads to prosperity. Not “spending” in general nor “fiscal expansion”.

    For fiscal expansion to lead to prosperity, it must increase productivity in creating goods that people value. Government isn’t all that good at this activity relative to competitive firms whose existence hinges on successful competition. If it were, it wouldn’t need to force people to pay for its services.

    Keynesianism fails for the same ultimate reasons that socialism fails, it’s just that the methodology and language employed by Keynesians seems to routinely conflate nominal growth and real growth.

    We can have fiscal expansion with nominal decline. We can have fiscal expansion with real decline. The government can grow as the over economy shrinks. We can have full employment even as the standard of living falls.

    Sumner’s “macro”, despite his dubious and counterproductive use of the word “stimulus”, is about a relatively simple microeconomic transaction: allowing the demand for money to be met by the supply of money. There is no real inverse to this. The inverse of increased demand for money is NOT a decrease in demand for “goods in general”. There is no such thing as a “general glut”. People hoard cash and forego particular goods. In so doing, they still transmit preferences.

    The state is unlikely to step in and purchase those specific goods for those specific people instead. Rather, “fiscal policy” amounts to something like this:

    Barry is freaked out and hoards cash. The government therefore borrows from Steve and gives the money to Fred to dig a ditch in another state. Barry is still freaked out.

    That’s NOT the same process as increasing the supply of money to meet demand. It can only be treated as if it is the same by employing too much aggregation.

    Scott, instead of “stimulus”, use “stabilize NGDP growth”. You’re not looking to incentivize people to spend. You’re looking to achieve monetary equilibrium. It’s different.

  53. Gravatar of ssumner ssumner
    19. May 2012 at 17:25

    Mike Sax, You said;

    “Again, notice that Cameron is about austerity and monetary stimulus. That is his formula. At this point the results are not encouraging.”

    Mike, Please tell me you are joking. Obama is about higher taxes on the rich, and at this point it doesn’t seem to be working. (Notice how I skim over the fact that his tax increases haven’t passed Congress yet. Think about it.)

    justanothereconomist:

    You said;

    “This Keynesian knows that fiscal expansion leads to prosperity which raises tax revenues and reduces social spending. So it’s no surprise that Sweden is running a surplus and Britain a deficit.”

    But Britain is the one that did the big stimulus (under the Labour party.) Where’s the boom producing all those revenues? Sweden’s been reducing it’s national debt.

    Sometimes I wonder if my commenters even bother to check the data before they post. Or do you just rely on reading Krugman?

    Greece is practicing tight money—everything else is an effect of the poverty produced by that tight money. (call it what you want.)

  54. Gravatar of Mike Sax Mike Sax
    19. May 2012 at 17:35

    Scott I guess we define austerity differntly. To me simply allowing the Bush tax cuts expire isn’t austerity. How is a 39.6% rate going to kill anyone? We had it in the 80s and it was a the greatest peacetime expansion in US history.

  55. Gravatar of Mike Sax Mike Sax
    19. May 2012 at 18:09

    Scott maybe I should give you a few examples of what I mean by austerity. Paul Ryan’s budget that priviatizes Medicare along with all it’s other deep cuts is austerity.

    Herman Cain’s regressive 9-9-9 flat tax is austerity. Raising taxes on the rich to pay for necessary government spending is not austerity. In my definition.

  56. Gravatar of Thoughts and Links on the Austerity Debate Thoughts and Links on the Austerity Debate
    19. May 2012 at 18:45

    [...] In this post Scott Sumner riffs on a recent Krugman post. Did you have any idea that Sweden ran a budget surplus of 2% of GDP in [...]

  57. Gravatar of What austerity looks like around the world|PolitifreakPolitifreak What austerity looks like around the world|PolitifreakPolitifreak
    22. May 2012 at 08:35

    [...] Austria, Italy, Belgium, and the Netherlands.) She cites a few economists, including Scott Sumner, who argue that spending cuts combined with more stimulus from Europe’s Central Bank is the way to [...]

  58. Gravatar of What austerity looks like around the world | Open Source Thinktank What austerity looks like around the world | Open Source Thinktank
    22. May 2012 at 11:24

    [...] — the rest are leaning more heavily on cuts.) She cites a few economists, including Scott Sumner, who argue that spending cuts combined with more stimulus from Europe’s Central Bank is the way to [...]

  59. Gravatar of What austerity looks like around the world – HOTTEST WORLD NEWS What austerity looks like around the world - HOTTEST WORLD NEWS
    23. May 2012 at 08:35

    [...] Austria, Italy, Belgium, and the Netherlands.) She cites a few economists, including Scott Sumner, who argue that spending cuts combined with more stimulus from Europe’s Central Bank is the way to [...]

  60. Gravatar of What austerity looks like around the world « Greek Left Review What austerity looks like around the world « Greek Left Review
    28. May 2012 at 04:17

    [...] there aren’t many countries that have tried this route. Sweden stands out as one country that has cut spending a bit while enjoying a big monetary stimulus from the [...]

  61. Gravatar of JBH JBH
    22. July 2012 at 20:16

    Austerity and tax increases will not solve the debt problem. The only solution that nobody is talking about, is to cancel the debt:

    http://www.goldstockbull.com/articles/worldwide-debt-default-jubilee-is-the-only-solution/

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