Get a Grip: Austerity Does Not Produce Prosperity

Austerity has suddenly become the universally prescribed cure for
the fallout from the financial collapse. If widely adopted, it will
prove worse than the disease.

The price of the rescues of Greece, Spain and Portugal will be
brutal deflation. The International Monetary Fund, which supposedly
learned from its earlier mistakes of imposing austerity on already
damaged economies, is back in cold-bath mode, demanding higher taxes
and dramatically reduced spending as its pound of flesh.

The European Central Bank and key leaders of the E.U. are promoting
economic pain as the price of relief. Here at home, President Obama has
sworn off serious new outlays for jobs or aid to the states, and is using his fiscal commission to pursue a bipartisan consensus on spending cuts and higher taxes.

The nations of the European Union are being treated as the object
lesson in the costs of profligacy. This is supposedly what happens when
you provide decent social benefits to regular people.
In fact, most of Europe had reasonably well-disciplined budgets until a
made-on-Wall-Street economic crisis took down their economies.

The budget deficit here and overseas does need to return to a more
moderate level -- after we get an economic recovery. But the problem
with the austerity treatment during a recession is that if everyone
tightens their belts at once, there is nobody to buy the products; the
economy shrinks and repayment of debt is even more arduous. As John
Maynard Keynes famously wrote, "The patient does not need rest. He
needs exercise."

You don't have to be a Keynesian to recognize that the economics of belt-tightening is a fool's errand in a recession.

With the exception of a few smaller nations, the large deficits in
the OECD countries are not the result of fiscal profligacy, but of
revenue losses caused by the downturn. And in the case of Greece,
supposedly the poster child for profligacy, the new Socialist
Papandreou government is having to clean up after the fiscal finagling
of its conservative predecessor. Greece certainly needs tax reform to
make sure that so many of its very wealthy do not hide their assets. It
does not need general austerity.

The US has been spared this phase of the crisis so far, because the
Federal Reserve has been willing to be buyer of last resort of all
manner of securities, including government debt. This remedy is far
from ideal, and it needs to be wound down as soon as recovery comes, as
well as combined with structural reforms. But the Fed rescue certainly
beats a total collapse

In Europe, by contrast, this rescue act is far more difficult
politically and institutionally. Sovereignty is divided along nations
pursuing their own self-interests, a fledgling E.U. and a central bank
that lacks either the Fed's full powers, its history, or its

But Europe had better come through this test as a more unified and
politically effective system or we will all suffer. This is no time for
skeptics of the Euro or the E.U. to be gloating.

In fact, the Germans and the French have put their self-interest
aside, and have pushed for a rescue plan that prevents default on
government bonds and benefits Europe's less affluent nations. With aid
to Greece monumentally unpopular, German Chancellor Angela Merkel was
willing to lose a key state election in order to prevent a Euro
collapse This statesmanship is admirable -- but the austerity demands
are not.

The current global economic crisis, now entering a new phase as a
crisis of sovereign debt, has only one rough precedent. The last time
major nations (such as Germany, its European creditors, and much of
Latin America) faced insolvency, the combination of financial collapse
and deflation helped create depression, dictatorship, and then World
War II.

In the US, we finally ended the Great Depression with massive
wartime borrowing and public outlay. We ended the war with a
debt-to-GDP ratio of more than 120 percent, more than double today's
ratio. In Britain, debt-to-GDP peaked at about 250 percent.

But all of the war spending recapitalized industry, re-employed and
trained jobless workers; and after the war pent up consumer demand
powered a record boom and rising revenues paid down the debt.

There was plenty of wartime sacrifice, but it was shared. Citizens
bought war bonds and used ration books. There were wage and price
controls. Surtaxes on high incomes were over 90 percent. Interest rates
were administered through a deal between the Treasury and the Fed, and
the war debt was financed with cheap money. Inflation rose slightly
after the war, but was manageable. And thanks to the deferred demand
and careful economic management of the war years, peacetime conversion
brought not a recession but a boom.

Today's situation is different. The origin of all the debt is not a
war but a financial collapse. The new round of financial panic is the
result of still fearful markets, a still fragile banking system, and
deficits caused mainly by reduced output, not overspending.

In this context, it is insane to think that we can recover from a
financial panic and an economic recession by inducing a worse recession
in the name of fiscal soundness. For now, while the real economy heals,
there is no substitute for aggressive central bank intervention to
restore markets in sovereign debt. The right grand bargain is tough
financial reform and limits on Wall Street--so that this crisis is
never repeated. The wrong grand bargain is austerity for everyone else.

Join the Movement: Become Part of the Solution Today

We're optimists who believe in the power of informed and engaged citizens to ignite and enact change to make the world a better place.

We're hundreds of thousands strong, but every single supporter counts.

Your contribution supports this new media model—free, independent, and dedicated to uncovering the truth. Stand with us in the fight for social justice, human rights, and equality. As a people-powered nonprofit news outlet, we cover the issues the corporate media never will. Join with us today!

Our work is licensed under Creative Commons (CC BY-NC-ND 3.0). Feel free to republish and share widely.