Veronique de Rugy on Austerity

In reply to Paul Krugman's numerous missives that the only way governments should react to the downturn is to spend, spend, spend, Veronique de Rugy has a piece in Reason that contradicts Krugman's points. (Yeah, I know, Reason gets Koch money, just as Krugman's people get Soros money. Call it a wash.)

Ms. de Rugy writes:

One of the key signaling devices for international investors is how a government behaves under financial duress—how it balances the demands of its debtors with those of its welfare recipients. Announcements of lower spending and higher taxes tell investors a country is willing to go to great lengths not to default on its debt obligations. If the government instead focuses on preserving its welfare state and public employee benefits, investors know default is more likely and will shy away from that country’s bonds.Japan has the world’s biggest debt as a percentage of GDP, at 227 percent, nearly four times the economist-recommended 60 percent ceiling. It has gotten away with its carelessness without risking default because the country relies more heavily than most on domestic investors to fund its follies. The United States, despite a dangerous debt burden relative to GDP (66 percent) and a structural deficit among the highest of developed countries (almost 4 percent), has so far also escaped investor censure, thanks to the perception that the dollar remains the safest currency in the world. European countries don’t have that luxury.

I would add that the people in power in this country act as though the U.S. Dollar is impervious to any kind of international challenge. They forget that just 40 years ago, that is precisely what happened, and the crisis of 1971 left the USD in the lurch.

She continues:

The notion that austerity is bad and stimulus is good rests on the Keynesian theory that if government spends a lot of money, that money will create more value in economic growth. This purported increase in gross domestic product is what economists call the “multiplier effect.” It’s a nice story, but like most fairy tales, it has scant basis in reality.

In a 2010 paper published by George Mason University’s Mercatus Center (where I work), economists Robert Barro and Charles Redlick showed that in the best-case scenario, a dollar of government spending produces much less than a dollar in economic growth—between 40 and 70 cents. If that was the rate of return on our private-sector investments, America would soon cease to be a leading economic force.

Barro and Redlick also looked at the economic impact of raising taxes to pay for spending increases. They found that for every $1 in tax-financed spending, the economy actually shrinks by $1.10. In other words, greater spending financed by tax increases damages the economy. The stimulus isn’t working, because the economic theory it is based on is fundamentally flawed.

As I said before, this piece is worth reading. Krugman won't like it, but people who actually believe that economics is more than just stuffing money into an economy of homogeneous factors are going to find it stimulating reading.