All the advanced economies (AEs)—USA, Europe, Japan—have implemented some form of ‘austerity policy’ in the wake of the 2008-09 global financial crash and deep recession that followed. Five years later, austerity continues as a centerpiece of their policy mix even as their economies continue to struggle with recurrent double and triple dip recessions (Eurozone, Japan) and, in the case of the USA, periodic relapses into single quarter negative GDP and ‘stop-go’ recovery. Real investment continues to gradually slow everywhere in the AEs, with insufficient wage growth, stagnating household consumption, and a slow but steady drift toward deflation everywhere.
One of the key global economic questions today is: ‘why austerity?’ More specifically, why do AE capitalist policy makers continue with austerity policy when it clearly hasn’t worked? Indeed, what does it really mean to say austerity ‘hasn’t worked’?
Professional economists are generally confused about these questions. Mainstream liberal economists like Paul Krugman, Alan Blinder, and Martin Wolf scratch their heads, perplexed, and wonder out loud in their weekly newspaper columns why politicians in the AE economies continue with their austerity policies, when it is clear such policies are contributing to preventing economic recovery.
Three Blind Economic Mice
In one of the more recent of his many New York Times columns criticizing austerity policies, entitled ‘Revenge of the Unforgiven’, Krugman notes that “The world economy appears to be stumbling” and that “growth is stalling, and the specter of deflation looms”. For Krugman austerity policies are one of the big causes, perhaps the main cause of this global slowdown, and especially the cause behind Europe’s current emerging third recession since 2009.
Krugman condemns austerity and asks “why do governments keep making these mistakes? In particular, why do they keep making the same mistakes, year after year?” In other words, austerity policies are the consequence of some kind of error or bad economic judgment. That error in judgment is attributed in turn to a moral failure on the part of policy makers, according to Krugman. Austerity policies continue due to “an excess of virtue. Righteousness is killing the world economy”. In the Eurozone the root of that excess virtue and righteousness is Germany, according to Krugman. It insists on maintaining an attitude of “moral indignation” toward debtors who refuse to pay their bills. If Germany would only not insist its neighbors pay their debts (to Euro Commissions, the IMF, and of course to German banks), its Euro neighbors could then abandon austerity and re-stimulate their economies with government spending. Krugman’s solution therefore is to get German policymakers to overcome their excessive virtue and sense of righteousness toward their neighbors, and just let them forego paying their debts (to German bankers and others). Better yet, expunge the debts. But that’s not likely to happen, Krugman adds, until a recession in Germany “will finally bring an end to this destructive reign of virtue”.
So the loss of virtue, excess righteousness—i.e. moral failure—explains why AE policymakers in general, and in the Eurozone and Germany in particular, have stuck to austerity for so long and want to continue it. And it was just a ‘mistake’ to introduce it in the first place. In this Krugman view, there’s no need to consider an analysis of political or economic interests—and especially class interests—as the source of austerity policies, or to explain why such policies have continued for more than five years now, or why they don’t appear about to be abandoned anytime soon. It’s all been just a mistake and continuation of austerity is due to moral stubbornness.
The UK economist and feature writer for the Financial Times, Martin Wolf, echoes the same themes of Krugman with regard to the UK economic experience since 2010: Its origins circa 2010 in the UK were “ a blunder” and “a huge mistake”. Its continuation “worse than a crime”. And those who insist on still pursuing it, like US president Hoover in the 1930s, are “both stupid and wicked” (moral arguments).
In a similar recent editorial in the Wall St. Journal attacking austerity programs, in a piece entitled “Enough with European Austerity, Bring On the Stimulus”, economist Alan Blinder, a former vice-chairman of the Federal Reserve in the USA, also declared that Euro austerity policy was due to a ‘mistake’. Once again the focus of attack is “German obsession with austerity” that “is holding back growth”. Germany is again the ‘bogeyman’ here, standing in the way of the heroic European Central Bank chairman, Mario Draghi. Blinder laments that instead of QE and more liquidity for the Euro banks, Europe is instead moving toward more ‘structural reforms’. But structural reforms are just “a potpourri of pro-market policies”, in his view, and will not lead to recovery. True enough. But what Blinder, the former USA central banker, proposes is dear to the heart of all central bankers: more free money to bankers and investors in the Eurozone—that is, more QE. If only the Germans would let poor Mario do his job! But the German central bank president, Jens Weidmann, “won’t budge—at least not yet”, according to Blinder.
Explanations of why austerity originated and why it continues like the foregoing, that are explained by ‘mistakes’ and the ‘moral attitudes’ of policy makers, tell us really nothing about the origins of and reasons for austerity policy’s origins, or why it has continued for more than five years now and continues still to morph into new forms today.
In fact, Krugman & Co. are asking the wrong question. More precisely, they are asking only half of the right question. When they concur that ‘austerity doesn’t work’, the sentence is incomplete. They should be asking ‘For whom does it not work’? For austerity does work, indeed is essential—for bankers, investors, corporations and the wealthiest households. It just doesn’t work for the rest.
Monetary Policy as Capitalist Preferred Solution
Austerity is a blatant class-based program. Its purpose is to enable capitalist policy makers to pursue their primary and preferred economic recovery strategy. That preferred strategy is based on monetary policy—not fiscal policy.
Back in 2008-09 AE policy makers jointly decided to rely primarily on AE central banks—the Federal Reserve, Bank of England, Bank of Japan, and the European Central Bank—as the prime institutions for managing economic recovery. The central banks, led by the USA Federal Reserve, together pumped massive liquidity (money) into the their banking systems in the belief that capitalist finance will then lead the way to economic recovery. The central bank tools employed were quantitative easing (QE), zero interest loans (ZIRP), special auctions where needed in severe emergencies, and what was called ‘forward guidance’ whereby central bank bureaucrats signal bankers and other big capitalists their direction and plans beforehand. Tens of trillions of dollars and other AE currencies were printed and otherwise provided to the private capitalist banking system. Private banks were thereafter supposed to lend to non-bank businesses, who would in turn invest and expand and hire new workers. Incomes would subsequently grow, consumer spending would rise, and GDP and economic growth return. At least that was the theory. Fiscal stimulus as government spending was considered unnecessary for recovery. Even when offered, it was token, temporary, and soon withdrawn once again.
The problem was, and still is, that despite tens of trillions of dollars provided to the private banking system, the private banks were not eager to lend to the vast majority of businesses, especially small and medium businesses. They loaned their central bank provided funds to other shadow banks globally, who speculated in various financial asset markets instead. Of course, that didn’t generate much in the way of real investment, jobs, incomes, consumer spending, and economic growth in the AEs. Much of that lending for financial investment went off shore to emerging markets in any event. Bankers also loaned to non-financial investment projects, but mostly again offshore to multinational corporations and to China and emerging markets. That too did not generate much real recovery in the AEs. A third thing bankers did with the central bank trillions given them was to buyback their stock and payout dividends. That raised their valuations and got bank senior managers nice bonuses. Thereafter the banks sat on their remaining cash—not insignificant sums—and hoarded it. In the USA alone that remaining cash hoard is reportedly today at around $2 trillion.
Given this scenario of the trillions of dollars provided by central banks to AE private banks, that did not direct it to the real economy to create investment, jobs, incomes, etc., AE policy makers ‘doubled down’ and provided the private banking system and investors even more liquidity in the hope that more liquidity would ensure some getting through. Zero interest rates were continued year after year and even more quantitative easing (QE) programs were introduced. In short, more monetary policy has always been the preferred policy of choice of all the AEs, even when it has produced few results.
After five years, it is now absolutely clear that everywhere in the AEs monetary policy in the form of central bank massive liquidity injections have been the primary policy choice for attempting to restart their economies after the 2008-09 crash. Fiscal policy in the form of government spending or even household tax reduction has never been on AE policy makers agenda anywhere for the past five years, regardless how much Krugman & Co. wish it were so. Monetary policy has always been—and still continues to be—prime. It has been the preferred policy choice of AE policy makers from the very beginning in 2009-10, and continues to be so today.
Austerity Policy as Necessary Complement
But that still doesn’t explain why cutting government spending, ‘negative fiscal policy’, or fiscal policy ‘in reverse’—i.e. austerity—has been part of AE policy mix for the past five years. The general answer to that is that austerity has accompanied the massive central bank liquidity expansion, the prime strategy of the AE policy makers, because austerity functions as a necessary complement to central bank massive liquidity injections.
Austerity is about keeping the lid on rising government debt and making ‘the rest of us’ pay for that debt, while waiting for monetary policy to restart financial markets and for the market system itself at some subsequent point to eventually generate economic growth. The problem is that this ‘monetary policy first’ approach and path to recovery only results in recovery very slowly, with significant delays, and with repeated relapses into short and shallow recessions. Monetary policy based recovery thus takes potentially a long period of time, typically five to ten years. It may prove even longer, as Japan’s economy since the early 1990s is a prime example.
Capitalists and their policy makers truly believe that the capitalist market will ‘correct itself’ in the longer run. They believe that the way to jump start that market-driven recovery is to do it via supply side policies. They believe that pumping massive money injections into the banks starts the supply side process. It’s the first step. After that, banks will lend, businesses will invest, jobs will return and consumers will spend once again. To put money directly into workers’ paychecks and consumer households first by government spending and investing (i.e. Krugman & Co. ‘Demand-Side’ view) relegates bankers and businesses to a secondary recovery position. Demand-side government spending policy means households, consumers and workers recover first, then it spreads to bankers and businesses as the former buy their products. For capitalist policy makers it is preferable to reverse that process: ensure that bankers and big businesses recover first and rapidly, then wait for the market system to eventually bring the rest along. And if it takes long, 5 years, 10 years, if the recovery is slow and intermittent, then rising government debt must be contained in the meantime. That’s where austerity policy comes in. If that debt is not contained the government debt rise may offset and even negate the monetary policy’s effect. So austerity must accompany a preferred monetary driven recovery policy. It is complementary and necessary to the primary and preferred monetary policy.
To the extent that austerity policies serve this function of containing the rise in government deficit and debt, then austerity policies ‘work’. Austerity policy therefore is not an ‘error’ or a moral failing when class interests are considered. AE capitalists and policy makers are not blind fools, or excessively righteous, or ‘wicked’, as Krugman and others would suggest. It is Krugman & Co. who are blind—to the real class based origins and functional purpose of austerity policies. They think that austerity policy is about a failed strategy for stimulating the economy. But that’s not what austerity is about. Nor is it a ‘mistake’ or due to moral failings. To put it succinctly, austerity is about making the general populace and the working classes pay for the monetary policy strategy’s slow, often interrupted, and limited impact on the real economic recovery.
So has ‘austerity’ failed? The answer is ‘failed for whom?’ In other words, it can’t be determined if it has failed apart from a class analysis of it. And that’s where the Krugman and others miss the whole purpose of austerity in the first place. And why are austerity policies continuing? Because so long as monetary policy continues to fail to generate a sustained and normal economic recovery, AE policymakers will continue with some form of austerity policy.
~ Dr. Jack Rasmus serves as Chair of the Federal Reserve on the Economy Branch of the Green Shadow Cabinet.