Did Krugman Win the Austerity Argument?
By Staff News & Analysis - April 25, 2013

The Economic Argument Is Over — Paul Krugman Has Won … For the past five years, a fierce war of words and policies has been fought in America and other economically challenged countries around the world. On one side were economists and politicians who wanted to increase government spending to offset weakness in the private sector. This "stimulus" spending, economists like Paul Krugman argued, would help reduce unemployment and prop up economic growth until the private sector healed itself and began to spend again … The argument is over. Paul Krugman has won. – Business Insider

Dominant Social Theme: The Keynesians emerge triumphant again.

Free-Market Analysis: The argument that the head of Business Insider Henry Blodget is making is that cutting government benefits and pursuing monopoly privatization doesn't help economies grow. Only printing debt-based fiat money can do that, apparently.

It is a ludicrous argument because all such money printing does – certainly when it is distributed through banks – is inflate certain securitized assets. But Blodget, who is actually a Keynesian despite the market-orientation of his 'Net-based editorial effort, is determined to make it.

He characterizes those who want troubled economies to adopt "austerity" as those who believe in "cutting spending to reduce deficits and restore confidence." Government stimulus, viewed this way, would only "increase debt loads, which were already alarmingly high."

Here's more:

If governments did not cut spending, countries would soon cross a deadly debt-to-GDP threshold, after which economic growth would be permanently impaired. The countries would also be beset by hyper-inflation, as bond investors suddenly freaked out and demanded higher interest rates.

Once government spending was cut, this theory went, deficits would shrink and "confidence" would return. This debate has not just been academic. It has affected the global economy, and, with it, the jobs and livelihoods of hundreds of millions of people.

Those in favor of economic stimulus won a brief victory in the depths of the financial crisis, with countries like the U.S. implementing stimulus packages. But the so-called "Austerians" fought back. And in the past several years, government policies in Europe and the U.S. have been shaped by the belief that governments had to cut spending or risk collapsing under the weight of staggering debts.

[But] Nobel-prize winning Paul Krugman and the other economists and politicians argued that governments could continue to spend aggressively until economic health was restored. And then, last week, a startling discovery obliterated one of the key premises upon which the whole austerity movement was based.

An academic paper that found that a ratio of 90%-debt-to-GDP was a threshold above which countries experienced slow or no economic growth was found to contain an arithmetic calculation error. Once the error was corrected, the "90% debt-to-GDP threshold" instantly disappeared. Higher government debt levels still correlated with slower economic growth, but the relationship was not nearly as pronounced. And there was no dangerous point-of-no-return that countries had to avoid exceeding at all costs. The discovery of this simple math error eliminated one of the key "facts" upon which the austerity movement was based. It also, in my opinion, settled the "stimulus vs. austerity" argument once and for all. …

The debunking of this paper has been huge news in the economic community, but what is just as big news is that it was used as justification for "austerity" in the first place. We are asked to believe that a paper by two fairly obscure economists was so important that it influenced the monetary and fiscal policies of the entire Western world.

And now that it has been proven wrong (was it ever right?) the foundations of Europe and the US with an aggregate of some US$30 trillion in GDP must shift once again. What a paper, eh? Didn't know economists had that kind of power …

In fact, they don't and to argue they do is a ludicrous assumption; it goes to the heart of what we like to call directed history. Those running Western economies were determined to impose the policy of "austerity" for a variety of reasons, some of which have to do with austerity's lack of results. The paper provided them with a justification and they seized on it.

Austerity is, in fact, an International Monetary Fund policy that, as one feedbacker recently noted, protects banks at the expense of national bureaucracies and the citizens caught up in the profligacy of their leaders.

Austerity is not really what Blodget states. Austerity does not "cut costs" so much as it reduces social safety nets and hacks at pensions while raising taxes and increasing various regulatory burdens. It is, in other words, austerity for citizens but not so much for their states.

Blodget and other socialists want to win the argument over state spending so they have seized on the debunking of this "study" as proof that national policies have been misguided and that financial leaders need to pump prime aggressively.

This is just as silly an argument as the "austerity" one – which is not austerity at all. What really needs to happen is that regulations need to be reduced as much as possible along with taxes and central bank activism. The less the state is involved in providing "solutions" to the problems it has caused, the better off long suffering citizens will be.

After Thoughts

You won't find this argument being made anywhere in the war of words currently raging. Activists on both sides have defined their terms; as usual, common sense has gone missing.