Saturday, February 11, 2012

George Osburne and Crowding-out

Paul Krugman reminds us of a June 22, 2010 speech by George Osburne where he made his case for fiscal austerity. These words jumped out at me:

Higher interest rates, more business failures, sharper rises in unemployment, and potentially even a catastrophic loss of confidence and the end of the recovery ... An economy where the state does not take almost half of all our national income, crowding out private endeavour.

The entirety of this speech reads like standard Republican fare with its call for cuts in government spending but no new taxes. To be fair, however, the advice given by the members of the Council of Economic Advisors to President Lyndon Johnson back in 1966 worried about higher interest rates and crowding-out. But the economy then was at full employment and the Federal Reserve was already raising interest rates to avoid demand pull inflation. We can’t blame Johnson’s Keynesian advisors for the lack of political will to adopt fiscal restraint when needed.

But the UK and the US economies over the past few years have been very different. As Osburne noted interest rates have been low but that is a reflection of very weak aggregate demand and staggering GDP gaps. Let’s turn to a recent speech by Christina Romer to see what Barack Obama was thinking just after the 2008 elections:

The very first meeting I ever had with the President-Elect was on exactly this topic. I was in Chicago in mid-November 2008 for my job interview. The President-Elect began the discussion by saying that the economy was very sick and there was not much more the Fed could do—so we needed to use fiscal policy.

The President-Elect back then seemed to be paying close attention to the liquidity trap blog posts by Paul Krugman. Alas – the actual fiscal stimulus we got was too little and not sustained. I’m sure defenders of the President could counter by noting that the Republican leaders have been uttering the nonsense we say from George Osburne back on June 22, 2010. I guess the best way to close my blog post is to turn the microphone back to Dr. Romer:

The one thing that has disillusioned me is the discussion of fiscal policy. Policymakers and far too many economists seem to be arguing from ideology rather than evidence. As I have described this evening, the evidence is stronger than it has ever been that fiscal policy matters—that fiscal stimulus helps the economy add jobs, and that reducing the budget deficit lowers growth at least in the near term. And yet, this evidence does not seem to be getting through to the legislative process. That is unacceptable. We are never going to solve our problems if we can’t agree at least on the facts. Evidence-based policymaking is essential if we are ever going to triumph over this recession and deal with our long-run budget problems.

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