The Economy Needs More Stimulation!

Robert J. ShillerProject Syndicate / Op-EdPublished: Thursday 19 January 2012
In his clas­sic Fable of the Bees: or, Pri­vate Vices, Pub­lick Ben­e­fits (1724), Bernard Man­dev­ille, the Dutch-born British philoso­pher and satirist, de­scribed – in verse – a pros­per­ous so­ci­ety (of bees) that sud­denly chose to make a virtue of aus­ter­ity, drop­ping all ex­cess ex­pen­di­ture and ex­trav­a­gant con­sump­tion. What then hap­pened?

The Price of Land and Houses falls;

Mirac’lous Palaces, whose Walls,

Like those of Thebes, were rais’d by Play

Are to be let; . . . .

The building Trade is quite destroy’d

Artificers are not employ’d; . . .

Those, that remain’d, grown temp’rate strive

Not how to spend, but how to live . . .


.

That sounds a lot like what many ad­vanced coun­tries have been going through, after fi­nan­cial-cri­sis-in­duced aus­ter­ity plans were launched, doesn’t it? Is Man­dev­ille a gen­uine prophet for our times?

Fable of the Bees de­vel­oped a wide fol­low­ing, and gen­er­ated sub­stan­tial con­tro­versy, which con­tin­ues to this day. The aus­ter­ity plans being adopted by gov­ern­ments in much of Eu­rope and else­where around the world, and the cur­tail­ment of con­sump­tion ex­pen­di­ture by in­di­vid­u­als as well, threaten to pro­duce a global re­ces­sion.

But how do we know if Man­dev­ille is right about aus­ter­ity? His re­search method – a long poem about his the­ory – is hardly con­vinc­ing to mod­ern ears.


“Fol­low Pro­ject Syn­di­cate on Face­book or Twit­ter. For more from Robert J. Shiller, click here.”

Har­vard econ­o­mist Al­berto Alesina re­cently sum­ma­rized ev­i­dence con­cern­ing whether gov­ern­ment deficit re­duc­tion – that is, ex­pen­di­ture cuts and/or tax in­creases – al­ways in­duces such neg­a­tive ef­fects: “The an­swer to this ques­tion is a loud no.” Some­times, even often, economies pros­per nicely after the gov­ern­ment’s deficit is sharply re­duced. Some­times, just maybe, the aus­ter­ity pro­gram boosts con­fi­dence in such a way as to ig­nite a re­cov­ery.

We have to ex­am­ine the issue with some care, un­der­stand­ing that the issue that Man­dev­ille raised is re­ally a sta­tis­ti­cal one: the out­come of gov­ern­ment deficit re­duc­tion is never en­tirely pre­dictable, so we can ask only how likely such a plan is to suc­ceed in restor­ing eco­nomic pros­per­ity. And the biggest prob­lem here is ac­count­ing for pos­si­ble re­verse causal­ity.

For ex­am­ple, if ev­i­dence of fu­ture eco­nomic strength makes a gov­ern­ment worry about eco­nomic over­heat­ing and in­fla­tion, it might try to cool do­mes­tic de­mand by rais­ing taxes and low­er­ing gov­ern­ment spend­ing. If the gov­ern­ment is only partly suc­cess­ful in pre­vent­ing eco­nomic over­heat­ing, it might nonethe­less ap­pear to ca­sual ob­servers that aus­ter­ity ac­tu­ally strength­ened the econ­omy.

Like­wise, the gov­ern­ment’s deficit might fall not be­cause of aus­ter­ity, but be­cause the stock mar­ket’s an­tic­i­pa­tion of eco­nomic growth fuels higher rev­enues from cap­i­tal-gains tax. Once again, we would see what might ap­pear, from look­ing at the gov­ern­ment deficit, to be an aus­ter­ity-to-pros­per­ity sce­nario.

Jaime Gua­jardo, Daniel Leigh, and An­drea Pesca­tori of the In­ter­na­tional Mon­e­tary Fund re­cently stud­ied aus­ter­ity plans im­ple­mented by gov­ern­ments in 17 coun­tries in the last 30 years. But their ap­proach dif­fered from that of pre­vi­ous re­searchers. They fo­cused on the gov­ern­ment’s in­tent, and looked at what of­fi­cials ac­tu­ally said, not just at the pat­tern of pub­lic debt. They read bud­get speeches, re­viewed sta­bil­ity pro­grams, and even watched news in­ter­views with gov­ern­ment fig­ures. They iden­ti­fied as aus­ter­ity plans only those cases in which gov­ern­ments im­posed tax hikes or spend­ing cuts be­cause they viewed it as a pru­dent pol­icy with po­ten­tial long-term ben­e­fits, not be­cause they were re­spond­ing to the short-term eco­nomic out­look and sought to re­duce the risk of over­heat­ing.

Their analy­sis found a clear ten­dency for aus­ter­ity pro­grams to re­duce con­sump­tion ex­pen­di­ture and weaken the econ­omy. That con­clu­sion, if valid, stands as a stern warn­ing to pol­i­cy­mak­ers today.

But crit­ics, such as Va­lerie Ramey of the Uni­ver­sity of Cal­i­for­nia at San Diego, think that Gua­jardo, Leigh, and Pesca­tori have not com­pletely proven their case. It is pos­si­ble, Ramey ar­gues, that their re­sults could re­flect a dif­fer­ent sort of re­verse causal­ity if gov­ern­ments are more likely to re­spond to high pub­lic-debt lev­els with aus­ter­ity pro­grams when they have rea­son to be­lieve that eco­nomic con­di­tions could make the debt bur­den es­pe­cially wor­ri­some.

That may seem un­likely – one would think that a bad eco­nomic out­look would in­cline gov­ern­ments to post­pone, rather than ac­cel­er­ate, aus­ter­ity mea­sures. And, in re­sponse to her com­ments, the au­thors did try to ac­count for the sever­ity of the gov­ern­ment’s debt prob­lem as per­ceived by the mar­kets at the time that the plans were im­ple­mented, find­ing very sim­i­lar re­sults. But Ramey could be right. One would then find that gov­ern­ment spend­ing cuts or tax hikes tend to be fol­lowed by bad eco­nomic times, even if the causal­ity runs the other way.

Ul­ti­mately, the prob­lem of judg­ing aus­ter­ity pro­grams is that econ­o­mists can­not run fully con­trolled ex­per­i­ments. When re­searchers tested Prozac on de­pressed pa­tients, they di­vided their sub­jects ran­domly into con­trol and ex­per­i­men­tal groups, and con­ducted many tri­als. We can­not do that with na­tional debt.

So do we have to con­clude that his­tor­i­cal analy­sis teaches us no use­ful lessons? Do we have to re­turn to the ab­stract rea­son­ing of Man­dev­ille and some of his suc­ces­sors, in­clud­ing John May­nard Keynes, who thought that there were rea­sons to ex­pect that aus­ter­ity would pro­duce de­pres­sions?

There is no ab­stract the­ory that can pre­dict how peo­ple will react to an aus­ter­ity pro­gram. We have no al­ter­na­tive but to look at the his­tor­i­cal ev­i­dence. And the ev­i­dence of Gua­jardo and his co-au­thors does show that de­lib­er­ate gov­ern­ment de­ci­sions to adopt aus­ter­ity pro­grams have tended to be fol­lowed by hard times.

Pol­i­cy­mak­ers can­not af­ford to wait decades for econ­o­mists to fig­ure out a de­fin­i­tive an­swer, which may never be found at all. But, judg­ing by the ev­i­dence that we have, aus­ter­ity pro­grams in Eu­rope and else­where ap­pear likely to yield dis­ap­point­ing re­sults.