Simon Wren Lewis Continues To Rewrite Economic History – What Really Works In Recessions?

It’s entirely true that in the recent economic unpleasantness we had a series of tests of orthodox economic theory. We’ve thus – given that science is about testing hypotheses – the opportunity at least to have more knowledge about what we need to do next time. Sadly, those who should be sifting through that evidence to produce the advice are sticking rather more to preconceived ideas than that evidence upon offer. Take Simon Wren Lewis as our example.

“The biggest policy mistake of the last decade” is the title of an article by Ryan Cooper, and the mistake is of course austerity. (It is a very US focused piece, so Brexit is not on the map.) Cooper goes through all the academics who gave reasons why austerity was necessary and how their analysis later fell to bits.

Hmm, well, according to Wren Lewis at least there was nowhere that didn’t have austerity so we’ve not exactly got a counter example on offer. But here’s the opening of that piece he’s praising:

In the great economic battle of the past decade, the winner is the tried and true — in a rout.

After the 2008 financial crisis, old-fashioned Keynesians offered a simple fix: Stimulate the economy. With idle capacity and unemployed workers, nations could restore economic production at essentially zero real cost. It helped the U.S. in the Great Depression and it could help the U.S. in the Great Recession too. But during and immediately after the crisis, neoliberal and conservative forces attacked the Keynesian school of thought from multiple directions. Stimulus couldn’t work because of some weird debt trigger condition, or because it would cause hyperinflation, or because unemployment was “structural,” or because of a “skills gap,” or because of adverse demographic trends.

Well going on 10 years later, the evidence is in: The anti-Keynesian forces have been proved conclusively mistaken on every single argument.

Well, no, not really. That is to entirely ignore the work of Milton Friedman, Anna Schwartz, and the Monetary History of the United States. Which insisted that the cause of the Depression – no, not the recession nor Crash that led to it – was errors in monetary policy by the Federal Reserve. Errors which were not repeated this time around (why, hello there QE!). St Milt was in fact correct here too.

Secondly, there’s no great or convincing evidence that anything Roosevelt did on any front lessened the Depression. That coming of WWII most assuredly helped but that’s a rather startling economic policy to recommend. We also do have a counter offer here, British economic policy was distinctly different at that same time. It was, in fact, expansionary fiscal contraction. Cut the budget deficit, rein in government spending – fiscal contraction. But at the same time overwhelm this with countervailing monetary policy. Come off the gold standard and depreciate sterling by 25%. It worked too. Britain recovered within 18 months.

The 1930s do not show that Keyenesian spending is the method out of recession or depression. Not on those two examples of the UK and US at least.

We all also seem to be ignoring the actual lessons of what was done this time around. The claim is that spending – specifically, government spending, financed by borrowing, on doing stuff like infrastructure, aids.

More clues that Alesina, Ardagna, Reinhart, and Rogoff got everything wrong can be found in the real world, where the Obama administration’s modest stimulus package, while too small to fix the Great Recession entirely, did make things much better.

Not really, as that $800 billion infrastructure stimulus didn’t work. Recall that it was to be spent upon “shovel ready projects”? Which, after two years, and a bit of foot shuffling, was replaced with an admission that there were no shovel ready projects worthy of the name? It didn’t work because it wasn’t even tried that is. The reality being that our modern world of permissions, hearings and licences cannot go spend money quickly. And how long has HS2 been around in the UK? Anyone seriously want to take a project with a decade long planning stage as being usefully stimulatory in recession?

Do note that I’m not talking about the effects of the automatic stabilisers but of discretionary increases in spending.

Conversely, the European countries that subjected themselves to severe austerity regimens saw their employment and production collapse, just like Keynes would have predicted. Greece, in particular, has suffered economic disaster considerably worse than the Great Depression in terms of output and unemployment.

Just like anyone interested in monetary policy would assume too. If you cannot devalue your way out of an over valued currency – thanks Mr. Euro – then you’re not going to be able to deploy monetary policy to solve your recessionary problems, are you?

In late 2010, a bunch of conservative financial and economics luminaries, including Michael Boskin, John Cogan, Niall Ferguson, Kevin Hassett, Douglas Holtz-Eakin, Bill Kristol, and John Taylor, signed an open letter to then-Fed Chair Ben Bernanke warning that “[t]he planned asset purchases risk currency debasement and inflation.” (Bernanke went ahead with his stimulus program anyway.)
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Yet it’s been six to eight years since their arguments and there’s hardly been a glimmer of the kind of inflation they warned about.
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In fact, not only has there been no hyperinflation, inflation has consistently come in under the Fed’s supposed target value of 2 percent.

Well, Bernanke is the nation’s leading scholar of Depression era monetary policy. Now that St Milt’s dead that is. And Bernanke’s actions all rather support, as their outcomes do, Friedman’s analysis, don’t they? Quite why this vindication of monetary policy is supposed to show the superiority of Keynesian fiscal policy is unknown. Unless of course all involved here are mere political partisans propagandising for their favourite policy.

As we have seen, the evidence for the Keynesian position is overwhelming. And that means the decade of pointless austerity has severely harmed the American economy — leaving us perhaps $3 trillion below the previous growth trend. Through a combination of bad faith, motivated reasoning, and sheer incompetence, austerians have directly created the problem their entire program was supposed to avoid. Good riddance.

The true horror of this is that even the claim is only that some other people were wrong. There is no evidence presented – none at all – to show that the proposed policy, that Keynesian stimulatory spending, would have worked. Not even a hand wave about how to get over that difficulty of spending in a land of licences.

Back to Wren Lewis:

The reason why economists like Alesina or Rogoff featured so much in the early discussion of austerity is not because they were influential, but because they were useful to provide some intellectual credibility to the policy that politicians of the right wanted to pursue. The influence of their work did not last long among academics, who now largely accept that there is no such thing as expansionary austerity or some danger point for debt. In contrast, the damage done by austerity does not seem to have done the politicians who promoted it much harm, in part because most of the media will keep insisting that maybe these politicians were right, but mainly because they are still in power.

Everyone does agree – when you lay it out like this – that expansionary austerity is possible, just as it was in the 1930s. Even Wren Lewis has agreed at times – if the effects of monetary expansion are greater than those of any fiscal contraction then we’ve expansionary austerity. And to claim there’s no danger point for debt is to dribble into one’s beard in a world where we’re wondering abut the effects of Greece’s 280% of GDP indebtedness on the country’s future economic growth. Sure, the limit might not be 90% of GDP but none? Pshaw.

Now, as it happens, I’m inclined to a belief in that general Keynesian contention. We’ve now proof that zero interest rates isn’t a bound, QE can leap such constraints. Hey, maybe it’s not even he best solution but it is one. We’ve also historical episodes of recovery from recession while cutting deficits – it depends upon greater monetary stimulus than fiscal consolidation. Even so, that general Keynesian idea, expand the budget deficit to prop up demand. OK, why not? But let’s do it in the only manner a modern government can achieve in anything timely. It cannot spend upon infrastructure because Swampy gets to come to the public inquiry. So, we need to do it the way Keynes suggested, cut national insurance:

I am converted to your proposal…for varying rates of contributions in good and bad times. (June 16, 1942). Keynes, Collected Writings, vol. 27, p. 208.

…[Y]ou are able to show fluctuations in income of an order of magnitude which is significant in the context… So far as employees are concerned, reductions in contributions are more likely to lead to increased expenditure as compared with saving than a reduction in income tax would, and are free from the objection to a reduction in income tax that the wealthier classes would benefit disproportionately. At the same time, the reduction to employers, operating as a mitigation of the costs of production, will come in particularly helpfully in bad times. (July 1, 1942). Keynes, Collected Writings, vol. 27, p. 218.

Which brings us to the real point at issue here. By my mind at least. There’s a general conflation across politics and economics, those who desire a larger state are more likely to support Keynesian economics – specifically, that ability to spend more in the bad times – than those who would prefer a smaller governmental intrusion into our lives. Of course, all Keynesians would protest that they are simply right on both points, not that their support for the one is linked to their desire for the other. Which gives us a useful test here, doesn’t it? If the correct, given bureaucratic constraints on raising spending, Keynesian response to recession is to lower taxation, not increase spending, will they still support Keynesian economics? Despite this painful realisation that it doesn’t expand the power and sway of the state?

I cannot speak for others but given the general vehemence with which all too many disagree with the less taxation is expansionary concept I think a lot of that support would drop away. But, you know, let’s find out, shall we? Who still supports Keynes when it doesn’t mean lashing the taxpayers’ cash?