Defining Austerity

I’m reading through the comments thread to Bob Murphy’s recent post on Paul Krugman and austerity. As expected, there’s some back-and-forth regarding what the definition of austerity is. One commentator chastises Bob for not considering the impact on tax hikes in Ireland, and somebody else responds that this isn’t really austerity. This is a simple definitional issue, so why hasn’t it been resolved? Why does the blogosphere continue to talk over itself? I think it has to do with what different economists perceive as the goal of an austerity program.

In The Return of Depression Economics,  Krugman discusses the different routes that East Asian countries decided to take during the crisis of the late 1990s. He gives two options,

  1. Currency devaluation to boost exports and lower real prices;
  2. Austerity to promote an aura of fiscal and monetary responsibility to woo investors.

The focus on investors, I think, is an important cause of differences in understanding. To Krugman, or whoever else has a similar worldview to his, the purpose of austerity is to retain investment by maintaining confidence — hence, why his “gotcha,” that austerity undermines confidence by depressing the economy further, seems so powerful. In this view, if one wants to pursue the austerity route, the most important thing a government can do is reduce its outstanding debt to create a semblance of sustainability. It follows that tax hikes are part of an austerity program, since it accomplishes what they perceive to be the objective of austerity: fiscal stability. It’s an argument  almost entirely dipped in the language of expectations.

Austrians don’t see it this way. The purpose of austerity isn’t necessarily to induce confidence — disregarding Robert Higgs’ regime uncertainty thesis1 (see “Regime Uncertainty“) —, but to allow real structural changes in the economy. What are structural changes? The reallocation of capital and labor. In this light, tax hikes are the antithesis to austerity. Sure, these help reduce deficits, but at the same time they represent a redistribution of wealth through a non-market process, subject to all the deficiencies I outline here. (It’s therefore unsurprising that both supply- and demand-side economists agree to tax cuts as stimulants.) To Austrians, this kind of austerity is a false austerity.

I suspect that there’s something else that Austrians have in mind when advocating austerity. Ideally, we’d see not only reduced government spending, but also important legislative changes that allow markets to better undertake resource reallocation: wage and labor market regulations, certain business regulations, et cetera. These might be lumped into the term “austerity” if only because of the focus on the role of government, but they don’t belong to the kind of austerity that Krugman has in mind (nor is it clear that they are austerity, since it has little to do with government spending).

These debates that are blinded by definitional issues seem silly. The more (or relatively) academic literature is not as sloppy. But, most bloggers, including academics, probably don’t read the relevant academic literature. Most of this is formed by working papers and think tank reports. When was the last time Krugman wrote about reading a Cato report? How many non-Keynesians read those periodic papers on fiscal multipliers, optimal tax rates, et cetera? Probably very few. It’s impossible to pack an equal amount of detail into blog posts.2 It’s no wonder we’re still debating over what austerity actually means.

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1. I don’t think regime uncertainty theory makes other considerations any less important, nor does it undermine them. Regime uncertainty is an added consequence of volatile policy changes, and policy changes with a particularly bad impact on business (e.g. the NRA during the Great Depression). I can see regime uncertainty having a negative impact even in the case of Austrian austerity. That changes in policy are reducing government’s reach doesn’t mean that all businessmen interpret this in the same way. It could be, for instance, that some thing the changes are only temporary (and thus any added profits are only temporary), or they could think that these changes will make things worse for them. Now, whether these theoretical costs (which would be at least partially neutralized by positive interpretations) outweigh the benefit is a separate question (and my answer is no).

2. Although, of all bloggers, Krugman is the least sloppy, precisely because he has a strong grasp of his side’s literature.

  • trolling

    “When was the last time Krugman wrote about reading a Cato report?” wait, i thought you said “academic literature”

    • http://economicthought.net/blog JCatalan

      Yea, that’s why I qualified academic with the parenthetical “relatively academic.” (I did almost laugh out loud, though.)

      • trolling

        you’re welcome, just playing around :)

  • Roberto Severino

    Finally! A rational and sane voice in this whole debate. Austerity, depending on you who talk to, can either be this horrible boogie man or a necessary kind of medicine. It’s hard to tell who is right on the issue when both sides are just as adamant about proving their points as the other.

    I wonder what a market monetarist would have to say about this.

  • Silvano

    Broadly speaking “Austerity” is a policy program of fiscal consolidation which is a mixture of tax hikes and spending cuts* usually without the possibility of absorbing AD shocks via exchange rates.

    Downsizing the scale of Government isn’t per se austerity. You can do that also in good times.

    *about spending cuts: it means cuts in public consumptions and investments and a shift from G to interest payments, so a program could be classified “austere” even if deficit / gdp is negative and so on. I say that because it seems to me too many people think “G” and the size of the government are the same thing which is basically wrong.

    • http://economicthought.net/blog JCatalan

      Right, the point of this post is that not all fiscal consolidations are made the same, and how different people view the objectives of austerity decides what kind of fiscal consolidation they’re looking for. That’s why Austrians aren’t keen on calling what’s going on in Europe as austerity, because it’s a kind of fiscal consolidation that doesn’t address their concerns. Further, when Austrians use the term austerity they really do mean reducing government spending, not reducing deficits per sé. It would be absurd, for instance, to say that a government is practicing austerity if it’s taxing incomes at 100 percent and raising spending accordingly, despite the fact that it’s deficit would still be zero.