Does Austerity Promote Economic Growth?

Jan 18, 2012 Robert J. Shiller

Policymakers cannot afford to wait decades for economists to figure out definitively how government austerity affects growth. But, judging by the evidence that we have, austerity programs in Europe and elsewhere appear likely to yield disappointing results.

NEW HAVEN – 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,

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Robert J. Shiller

Writing for PS since 2003
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Robert J. Shiller, a 2013 Nobel laureate in economics, is Professor of Economics at Yale University and the co-creator of the Case-Shiller Index of US house prices. He is the author of Irrational Exuberance, the third edition of which was published in January 2015, and, most recently, Phishing for Phools: The Economics of Manipulation and Deception, co-authored with George Akerlof. His forthcoming book is Narrative Economics: How Stories Go Viral and Drive Major Economic Events.

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Helena Hessel Jan 26, 2012

I do not agree that the issue is purely statistical. The
important issue is a 'qualitative' aspect of deficits. What are the reasons for government running/increasing/decreasing deficits? In the recent crisis, rising deficits in Iceland and/ or Ireland are 'qualitatively' very different from those in Greece or Portugal, for example. 'Putting' all deficits into the same basket and running a regression leads to confusing
results and interpretations.
If rising deficits results from the cut in taxes (benefitting mostly) rich (as in the U.S before the crisis), for example, the cut in spending to reduce them would lead to serious drop in growth. The issue , at hand, is really more political than a problem of uncontrolled experiment.
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Robert Goldschmidt Jan 25, 2012

The author begs the question of how we measure a country's economic strength. GDP and corporate profits are not the best measure as they are distorted by deficits and trade. Perhaps the most accurate measure is aggregate wage-based demand. But even this measure needs to be adjusted (i.e. intrinsic wage-based demand) by removing the wages attributable to government deficits.

Looked at in this light, the effects of policy changes can be more easily anticipated and measured. For example, one can show that intrinsic demand has been falling for four decades in the US and that outsourcing to low-wage countries, automation and oil depletion are the structural sources of demand destruction.
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