It's Alberto Alesina's World and We're All Just Unemployed in It

Mar 5, 2013Mike Konczal

In March 2011, the new Tea Party had taken over the House, and it needed a plan for what it would do about the deficit. It proposed that the effects of imposing austerity, even when the economy is weak, "may be strong enough to make fiscal consolidation programs expansionary in the short term." How did it propose we cut the budget? We can look at Joint Economic Committee (JEC) Republican report, "Spend Less, Owe Less, Grow the Economy," for the answer:

The Tea Party's study called for 85 percent spending cuts and 15 percent revenue increases. This was based largely off a 2009 study by Alberto Alesina and Silvia Ardagna of Harvard titled "Large changes in fiscal policy: taxes versus spending." This is the ur-text of expansionary austerity, which made the case, for example, "On the demand side, a fiscal adjustment may be expansionary if agents believe that the fiscal tightening generates a change in regime that 'eliminates the need for larger, maybe much more disruptive adjustments in the future.'"

Flash forward two years from that report to March 2013. President Obama and Congress have overseen $4 trillion dollars in deficit reduction set for the next ten years. What do the percentages look like? Here's a graphic from a recent New York Times blog post by Steve Rattner on the deficit deals:

Rattner points out that less than 20 percent has come from tax increases, just like Alesina called for. James Pethokoukis also noted these numbers and their connection to Alesina's work and referred to them as the "right" kind of austerity. But what does "right" mean here? There's a technical definition on changes to debt-to-GDP from the paper, but there's also the argument that the "right" kind of austerity would be "be less recessionary or even have a positive impact on growth."

That hasn't happened. In fact, the exact opposite is in play. Instead of expanding the economy, or even having little or no short-term effect, economists generally agree that this austerity (e.g. the sequestration) is cutting growth and reducing the number of jobs created. Suzy Khimm collects some numbers here, including Barclay's estimate, "In 2013, the fiscal drag from government austerity is expected to be between 1.5 and 2.0 percentage points." Where's the expansion? Where's the short-term confidence? This has been a complete failure.

Paul Krugman recently pointed out some choice quotes on who was right and who was wrong about Europe. To give you a sense of the mindset that created this line of reasoning, a set of arguments we are now trying out in the United States, let's look at how Alesina approached initial criticism of his work. In "The Boom Not The Slump: The Right Time For Austerity," my colleague Arjun Jayadev and I found that in virtually all the cases the adjustments were made when the economy was healthy, and in the few cases where it was not there was export-driven growth or interest rates were lowered (see also this Jared Bernstein summary of CRS' critique).

In a September 2010 paper for the Mercatus Center, here is how Alesina responded (my bold):

A recent paper by Jayadem and Konzcal [sic] (2010) argues that Alesina and Ardagna’s results do not apply to the current situation because fiscal adjustments on the spending side are expansionary only when they occur when the economy is already expanding. The criticisms of that paper are at best overstated... In addition, what is unfolding currently in Europe directly contradicts Jayadev and Konczal. Several European countries have started drastic plans of fiscal adjustment in the middle of a fragile recovery. At the time of this writing, it appears that European speed of recovery is sustained, faster than that of  the U.S., and the ECB has recently significantly raised growth forecasts for the Euro area.

I wonder how that ever turned out, even for just their debt-to-GDP ratios? Graph is from 2011-2012:

You can laugh, and you should, but do keep in mind all that needless suffering and the fact that this assessment of Europe's situation is what is now driving our fiscal policy.

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