A Global 1937, by Paul Krugman, in NY Times: Back in 2009, when there was (briefly) a policy consensus in favor of active fiscal policy to fight the slump, there were many warnings to the effect that we must not repeat the infamous mistake of 1937, in which FDR was persuaded to focus on balancing the budget while the economy was still weak, terminating the recovery from 1933 and sending America into the second leg of the Great Depression.
And what policy makers proceeded to do was, of course, to repeat the mistake of 1937.
The new IMF World Economic Outlook is, in effect, an extensively documented exercise in hand-wringing over the consequences of this repeat of bad history. Kudos to the Fund for having the courage to say this, which means bucking some powerful players as well as admitting that its own analysis was flawed.
There is, however, one point I think is getting skewed in the discussion of the IMF’s new concern over premature austerity. Much of the discussion seems to focus on the question of relaxing the demands on debtor countries — which is certainly a crucial issue for the eurozone. However, the global 1937 we’re now experiencing isn’t just about forced austerity in Spain, Greece, etc.. It’s also — and I think mainly — about unforced austerity in countries that remain able to borrow very cheaply.
Let’s look at estimates of the cyclically adjusted budget deficit from the IMF’s Fiscal Monitor, measured as a percentage of potential GDP. I don’t think you want to take these numbers as gospel — for Britain, at least, there’s a very good case that the IMF is greatly understating potential output and hence overstating the structural deficit, and I suspect that this is true to a lesser extent for the US. But in any case the point is that even cheap-money countries facing no pressure either from the market or from external forces to engage in immediate austerity are nonetheless engaged in sharp fiscal contraction:
This is taking place in an environment in which the private sector is still deleveraging ferociously from the debt binge of the previous decade; so we’re creating a situation in which both the private sector and the public sector are trying to slash spending relative to income. And whaddya know, the world economy is sputtering.
The truly amazing thing is that this calamitous error is not, for the most part, the result of special interests, or an unwillingness to make hard choices. On the contrary, it’s being driven by Very Serious People who pride themselves on their willingness to make hard choices (which, naturally, involve inflicting pain on other people). In fact, I’d argue that the desire to make hard choices, or at least to be seen as doing so, is the reason the VSPs chose to ignore the extensive and, we now know, completely accurate warnings from some economists of what would happen if they gave in to their austerity obsession.
FT Alphaville says that I’m feeling a bit “smuggish” about all this; well, I’m only human. But truly, this is a terrible thing to behold.