The Case for Austerity

I support larger stimulus and greater deficits. This is because the private sector is still overleveraged, and wants to increase its net financial assets. The deleveraging process is reducing aggregate demand, and getting to a debt level that the sector can service out of income via default will bring with it massively higher unemployment, and thus real output losses. Our current 10% unemployment rate is already too high, and the real output losses acute. So, let's stimulate through higher deficits.

Let me now try to make a case for Austerity.

The credit crises exposed distribution that seems unfair to the electorate. Or at least grossly inefficient. For example, the financial sector is remunerated multiple times above the non-financial private sector, and yet, once you factor in the cost of bailouts, seems to net destroy wealth. This seems unfair, or at least, grossly inefficient. Much of the Obama administration's stimulus has benefited the financial sector directly, supporting and extending this practise.

Public sector unions such as the SEIU and the teachers union, especially in California, have lavish benefits and retirement packages that they can juke to increase to obscene levels. At the same time, they enjoy extreme job security in a system that does not seem to reward competence or productivity. In California, young promising teachers are fired while teachers on probation (and therefore, not teaching) get paid full salaries for years. Again, this seems unjust, or at least, grossly inefficient.

And Greece has a large public sector, which draws the best and the brightest for its generous compensation and job security, while the Germans work hard, save, and export all the fruits of their labor so they can save some more. The Germans tighten their belts, while the Greeks strike so they can keep retiring at 60. This may seem unjust, or at least grossly inefficient, to the Germans.

And, at ground zero, irresponsible homeowners took on massive loans they could not afford, which inflated the price of housing leaving the prudent "priced out forever". An ocean of tax breaks, bailouts, hand outs, ZIRP, etc. have all focused on helping the irresponsible homeowner, keeping house prices high, and the prudent stuck on the sidelines.

All of these situations are political, and as Rahm noted, you need a great crises to tackle them. So far, stimulus has taken the form of extending and further entrenching the inefficiency and malinvestment. All of this has real cost, in badly allocated resources, lost opportunity, and a further corrosion of the polity (such as it is). If this be "stimulus", the Austerians might say, then maybe it is time to "purge the rot from the system".

If stimulus took the form of flat rate, per capita transfers, then we could purge the rot while protecting employment. But unfortunately, academic macroeconomics does not understand that Government deficits fund net private savings, and so it managed aggregate demand for savings through unemployment and not through appropriate fiscal policy.