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There are two groups of economists: scientists who predicted that austerity wouldn't work and would make things worse, and quarks (aka the Chicago school) who recommended it.

In most areas of science bad ideas don't disappear, it is just that those who support them die and ideas with some evidentiary support become the new norm.

After the response to the 70's oil shocks economists knew that austerity didn't work. Unfortunately measures that are known to work are a political minefield, so those "economists" who don't support it get a lot of support from politicians who don't support it either.

In some ways it is similar to evolution or climate change. You can find "scientists" who deny them both. Economics is worse though, because it is so closely tied to politics.

Incidentally, Krugman has been writing about Iceland since 2010[1].

[1] http://krugman.blogs.nytimes.com/2010/06/30/the-icelandic-po...

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No economist calls themselves a scientist. They call themselves economists.

The term 'austerity' is meant to apply to a government living within its means. These days it is applied to a government with single digit debt growth instead of double-digit growth. Kind of like how eating balanced meals is now called dieting.

It's true that you can avoid unemployment by borrowing money to pay people to dig holes and fill them in again. What is also true is that, without production there is no consumption. Digging up holes and filling them in is not production, ergo, consumption will not rise.

TLDR; J.B. Say was right. Keynes was wrong.

Nobody knows if Keynes was right - he advocated going into debt during recessions and then paying off the debt in periods of growth. The problem is the way large groups of people vote governments take on debt during recessions... and then take on even more debt during periods of growth.

That is to say, while his prescription may have been sound economically (I doubt it, but let's say it is for the sake of argument), politically it's just an excuse to pile on ever larger debts.

The term 'austerity' is meant to apply to a government living within its means.

No, it is meant to apply to a government radically cutting spending during a recession.

And yet Keynesian stimulus worked in Australia[1]. Australia was able to implement it properly because the Australian economy had run years of surplus budgets prior to the financial crisis.

The jibe about digging holes is disappointing and ignorant. The Australian program involved a one off payment to tax payers for immediate effect (which ended up supporting the retail sector at Christmas time), traditional infrastructure spending on "ready to go" projects (roads etc) for effect in a couple of months and a very large school building program where building usually started 6-9 months after the initial crisis. These programs were production and - more importantly - all supported employment.

TLDR; Keynesian economics works just fine when the government runs expansionary budgets when growth is needed and surpluses when growth is robust.

[1] http://en.wikipedia.org/wiki/National_fiscal_policy_response...

And yet all the countries that have slashed government spending and backstopped private debt have also taken a nose dive in GDP. Eppur si muove.

TLDR; Keynes advocated government spending on infrastructure (increased collective efficiency) not pointless hole filling.

Here is why this government spending recommendation is just a head fake: assuming the economy can be in a functional state at all, it is obviously true that if the government would spend money on the right things, it could create a functional economy. The real problem of economics however is resource allocation, or in this case, what should the government spend the money on. The proponents of government spending don't give any details - they don't solve the problem at all. They just market themselves as prophets by spouting trivial truths (spending money on the right things is good).

You'll answer "spending money on infrastructure" but that is not good enough. Even for roads there is a point when enough is enough (imagine every square meter of the country covered in roads).

To fix the economy, you have to devise a mechanism of efficient resource allocation. Just saying "let the government decide" is not an answer.

Put simply, you are outright lying.

Advocates of Keynesian spending advocate its usage for public goods and commons goods, the two known categories where "the government" is clearly more efficient than markets.

Does that mean no decisions remain in the realm of politics and everything turns into a technocratic utopia run by Economics majors? No. But that's because in any case there is no such thing as an apolitical economic policy of any kind. All of it, right down the property laws themselves, is political.

In fact, it's generally the very core of politics.

"public goods and commons goods, the two known categories where "the government" is clearly more efficient than markets."

Could you give me a reference for that? I am not an expert in economics, and that claim seems very doubful to me. Unless you are saying governments are good in spending money - yes, they are (getting rid of money, I mean).

The rest of your post, I am not sure what you are going on about. Yes, property laws are political (and some countries famously got rid of them, which for now has to be considered a failure). But what does that have to do with Keynesian spending? Also I admit I am not an expert on Keynes, but I suspect that puts me on par with most other people who have an opinion on it and advocate to just print more money.

http://en.wikipedia.org/wiki/Public_goods

Actually, advocating printing money is not a Keynesian position, it's a Modern Monetary Theory position.

But anyway, I'm arguing against your assertion that political decisions cannot and should not be made about the economy.

I did not make that assertion, what I said is that the advocates of government spending only shift the burden of decision making and don't really propose anything at all. Or in other words, the claim "government spending can fix the economy" is trivially true but useless.

The link about public goods doesn't convince me that government spending on public goods is always the best choice, see example of too many roads.

As for printing money, isn't it kind of equivalent to taking on debt?

what I said is that the advocates of government spending only shift the burden of decision making and don't really propose anything at all.

Of course, advocates of privatization are doing the same thing: shifting the decision-making and not really proposing anything at all. Both markets and governments are voting mechanisms.

Difference is, in a market, the dollars vote, and in a government, the people vote.

Then we have to start talking about the signal/noise ratios of both mechanisms...

Markets are a mechanism for allocating resources.

Of course, there is neither the perfect market nor the perfect government.

It seems to me that the potential for abuse is greater in the government, though. There is one vote every x years, and good tracking mechanisms of what is really being done don't exist yet.

Signal/noise - the difference is that in the market, participants can not simply spend other people's money. They have to come up with real money somehow, which might be a pretty strong signal.

Actually, austerity means the government using a lot of it's money to bail out failing banks and other private institutions and then saying it has no more money for the people and social services.

Estonia and Latvia are doing pretty well with austerity: <http://www.businessweek.com/articles/2012-07-19/krugmenistan...;

It's understandable that regular readers of Krugman may not know this since he goes to great pains to deny the obvious on this point.

I think you missed the point of that whole exercise... Latvia and Estonia have tiny, almost insignificant economies, literally smaller than 49/50 US states. The lessons there are clearly not applicable to the US, or if you prefer, policies for the US shouldn't be applied to either of them.

Additionally, they aren't doing "pretty well" with austerity by any honest metric. Even four years after the GFC, their GDPs are still below where they were in 2007/2008, significantly in Latvia's case. Unemployment is extremely high (From 4%/6% in 2007 to 10%/14% today) and wages have fallen.

Where is the success story here?

Lat + Est Unemployment: (https://www.google.com/publicdata/explore?ds=z8o7pt6rd5uqa6_...) Lat + Est GDP: (https://www.google.com/publicdata/explore?ds=d5bncppjof8f9_&...)

Iceland is much smaller than either, yet it is the poster child for this thread.

Using 2007 as the starting year for Latvia and Estonia is kind of cherry picking. See here: http://marginalrevolution.com/marginalrevolution/2012/07/the...

Note that the MR post is polite and humble, and gives fair consideration to both sides of the issue, unlike just about anything written by a certain ny times columnist.

Is it cherry-picking? I don't feel that it is. That GDP graph shows a normal moderate growth from 2000 right through to the crash. There was the slightest of upticks in the last year before the crash, but hardly enough to qualify as a boom. Which means that it is entirely fair to categorize Estonia's economic performance as normal just before the crash, and pretty lousy since.

At any rate, I was in Tallinn in June of this year, and the locals I talked to in bars and cafes were all very pessimistic about how the country was going. Maybe pessimism is just a cultural norm, but everyone that I asked felt that Estonia had gone backwards since the crash, and was still doing so...

If you look at the graph with the longer time horizon, you can see that Estonia, Lithuania and Latvia had stronger growth pre-crisis, a bigger bubble, a bigger collapse from the bubble, and a stronger recovery from the performance trough. Only by measuring by performance from their GDP peak do they look bad, and it's not obvious why this is the natural measure of recovery policies. You would think performance from the trough of the crisis or from some neutral pre-crisis point would be more relevant.

Here is another article with more graphs explaining this point: http://blogs.cfr.org/geographics/2012/07/02/postcrisis/ -- though you will find some debate in the comments.

Unemployment is extremely high (From 4%/6% in 2007 to 10%/14% today)

LOL! I wish we had that "extremely high" unemployment in Spain. By the way, we're an even better example of austerity not working.

It's not even the real unemployment number, because that unemployment only counts the registed unemployed (who are registered at the Employment Office and receiving financial aid for job-seeking). The actual number of unemployed and people working without taxes is much higher (how much higher, nobody knows).

Yet Krugman derives his ideology from a tiny babysitting ring that didn't print enough money. Even smaller sample than Estonia...

I'm glad you were the one to point out that Krugman has become so fixated with denying the obvious that it has become embarrassing. Continually pointing out that Japan hasn't get gone broke isn't much of a defense when their economy - once the envy of the world - has completed two decades of stagnation and shows no signs of recovery.

Had Japan done a Iceland-style cleanout, they would probably be still striking fear into the hearts of governments and corporates everywhere.

Except for one complication. Japan's public debt is largely owed to it's own citizens, such a large proportion being internal debt. Even if they defaulted on the external component, they'd still have a problem of the type Iceland could avoid. Iceland wrote off banking debt, which was something like 70% of their external debt.

I don't think the term you want is "write off". Creditors write off debt. Borrowers default.

You're right, my language was imprecise, and I'm conflating two events. The Icelandic government declined to recapitalize failing banks, even when under enormous pressure to do so by the UK government and others. The pressure you may know was partly due to various local government bodies and other institutions having deposits with Icelandic banks.

Because the Icelandic government declined to act as insurer for those deposits, the insolvency of them was seen as an effective write off of national indebtedness to other sovereigns.

Agree it's not the same thing though.

No problem. I just get worried that people hear about corporations or nations "writing off" debt and wonder why the system is rigged so they can't "write off" their own debts. Of course you can, as long as those debts are owed to you and not by you.

OK, it's true that by some metrics (government debt for example), Estonia is doing pretty well. But Estonia's private sector debt (personal loans) is still over the top and is actually killing the workforce right now. Because of these loans, the wages aren't rising, even though the cost of living is thanks to joining the euro zone. http://statistikaamet.wordpress.com/2011/05/27/eestist-valja... (Estonia's department of statistics blog) has statistics about the year 2010, where the graph shows the most dominant age group of emigrants are men in the age of 25-29 and most people leave the country because of high unemployment. That's men and women leaving in their best working age, most of whom will never return.

So, yeah, Estonia might be doing fine by some short-term metrics, but in the long term austerity measures have done irreparable harm.

I don't think we have entered the long term yet, so how can you so confidently say what the long term effects are?

Yes, and Japan, the country he's held out as a great Keynesian success in the past, is going over the falls right before our eyes:

http://globaleconomicanalysis.blogspot.com/2012/12/kyle-bass...

>There are two groups of economists: scientists who predicted that austerity wouldn't work and would make things worse, and quarks (aka the Chicago school) who recommended it.

Oh please. The idea that you can spend your way out of debt has been shown to be disastrous over and over, and yet like the Marxist "scientists" before them these Neo-Keynesians are going to claim everything is peachy until even the slowest among us can see they're wrong (and not scientists, either). But like any good faith healer they'll say "You didn't do it hard enough". Does that sound familiar?

In the short run austerity is painful. In the long run it's the only option, and putting off the pain only makes it worse when you're out of options. Either you do it honestly by cutting expenditures, or you do it the normal way by printing money.

The idea you can derive globally applicable lessons from a country the size of Cleveland is a bit daft.

"The idea that you can spend your way out of debt has been shown to be disastrous over and over,"

The idea is not that you can spend your way out of debt, that would be silly. The idea is that you can and should spend money to compensate for lack of demand in a recession, because the markets overshoot. Once you are out of recession, you must pay back the debt.

So austerity when the economy is good, spending when it is bad. Anti-cyclical government behavior.

Austerity in a recession is pro-cyclical. As was predicted and Greece (for example) has shown, a government cannot save itself out of debt in a recession, because tanking the economy at a crucial time like that makes the debt worse (as percent of GDP, and that's the crucial number in terms of ability to repay).

Update:

I am German, "living within your means" is sort of part of my DNA, and not living within your means is going to cause problems. But timing does matter!

Totally agree. But then the question becomes, what do you do when countries actually increase spending and debt when the economy is good, and therefore have nothing to spend when the bad times arrive. The main distinction between Iceland and Ireland is that Iceland can print its own money.

In the UK it seems that 'nasty' parties that advocate spending cuts in the good times get voted out of office, and replaced by parties that increase spending.

So it becomes less a question of economics and more one of politics. For the moment Germany might see "living within your means" part of the DNA, but few other countries do. And I imagine that, as Germany gets further integrated with the rest of Europe, that kind of thinking will be weakened.

"But then the question becomes, what do you do when countries actually increase spending and debt when the economy is good, and therefore have nothing to spend when the bad times arrive." "So it becomes less a question of economics and more one of politics."

Precisely. And all the western countries have been guilty of this, the only difference is that of degree. Which is why debt has generally only crept up and politics has slowly but surely ceded sovereignty to the banks, especially in Europe where new currency is apparently only created via commercial banks (unlike the US, which just prints it).

"And I imagine that, as Germany gets further integrated with the rest of Europe, that kind of thinking will be weakened."

As far as I can tell that's the current political struggle, especially between the North and South.

If Cleveland had its own currency, you could derive globally applicable lessons. But it doesn't.

The "normal way" is much much better than deflationary expenditure cutting. Deflation increases the debt burden in real terms.

The underlying reason governments are following austerity is because protecting old people's benefits & pensions (the people on the credit side of the debt, i.e. claims on future production) is more important than growing the economy for young people, because that's how the votes are structured in the economies that matter (Germany in Europe). Politics and demographics are pro-austerity, not economists.

Going into endless debt does not grow economies any more than running up your credit cards makes you wealthier. It just gives you the illusion of growth. If you want to see where this leads look at what happens in Japan over the next 12 to 18 months.

And anybody who lived through the Carter years understands high inflation is something to be avoided at all costs. It's not a stimulant to the economy, it's a drag. Companies don't know what the real return on their money will be so they don't make investments.

>Politics and demographics are pro-austerity, not economists.

Nonsense. Politics is very, very, very anti-austerity. Governments do not get smaller without a major upheaval. Look at the UK, where you hear much wailing and gnashing of teeth over "austerity" that's simply a tiny cut in the rate of growth of the budget.

Projected cuts of 10% next year on top of the already in the pipeline cuts of 25% would be difficult to sell as "a tiny cut in the _rate of growth_ of the budget". The cuts to government capital expenditure has been largely the cause for the contraction in the construction [1], which has in turn contributed to the UK going back into recession.

Borrowing in order to increase sales (taxes in the case of governments) or to decrease costs (increase economic efficiency, spending on infrastructure and the like) is a good idea; both companies and governments do this all the time. Borrowing to spend frivolously is a bad idea no matter who you are.

[1] http://www.guardian.co.uk/business/2012/apr/25/eurozone-cris...

>Borrowing in order to increase sales (taxes in the case of governments) or to decrease costs (increase economic efficiency, spending on infrastructure and the like) is a good idea

It can be a good idea if the economic activity that results covers the cost of borrowing. But that's not an easy thing to determine, and any rational start to the process tends to get warped by political reality. The fetish for infrastructure spending results in, for example, rail projects that lose ¥32 for every ¥1 they take in:

http://spikejapan.wordpress.com/2012/05/20/minispike-the-end...

And anybody who lived through the Carter years understands high inflation is something to be avoided at all costs. It's not a stimulant to the economy, it's a drag.

And everyone who remembers the Great Depression says the same thing about deflationary spirals.

I would rather see a depression than runaway inflation.

...we may have very few humans left of that era

If Cleveland had its own currency, you could derive globally applicable lessons. But it doesn't.

Well, Ireland, Spain, Portugal, Greece, etc don't either.

Iceland does, and they used it to sort themselves out.

The scary thing about Krugman is that his whole ideology seems to depend on that example of one babysitting exchange ring that didn't print enough money and therefore couldn't trade. It's an interesting story, but I wouldn't simply translate it to whole economies of nations. I can think of a lots of other factors that might have made the babysitting ring fail.

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