The concerted global fiscal stimulus of 2009 is an example of excellent policy-making, the more outstanding because subsequent policies have been ineffectual in addressing the weak recovery in advanced economies. Why did success morph so quickly into the fiscal policy lethargy of the past three years?
Usually, economies bounce back quickly after a downturn: the greater the downturn, the faster the recovery. Not so this time. Nearly five years after the nadir, the US and the UK still have unemployment close to 8% and the European Union has almost 12% (this doesn't just reflect the shocking unemployment figures in Spain and Greece; even France has unemployment well over 10%).
Given the success of the 2009 fiscal stimulus (a rare example of international economic coordination, associated with the London G20 meeting), the premature shift to austerity in 2010 needs some explanation.
Part of the answer lies in the very success of the 2009 stimulus. In early 2009 the IMF was forecasting a GDP plunge of 2.5% for the advanced countries over the course of that year, but the fall turned out to be less than 0.5%. The predicted growth of only 1% during 2010 turned out to be over 2%. This was hardly tear-away growth, but was enough to shift the focus from the immediate need for fiscal expansion towards the longer term issue of unsustainable government debt.
Meanwhile, Greece's bankruptcy became glaringly public in early 2010, with knock-on effects to Spain and Italy. Iceland, Portugal and Ireland added their own debt problems. Continental Europe was in no position to advocate fiscal expansion, and the UK was in no mood to do so. [fold]
Some commentators gave a positive spin to austerity, though it's not clear that those academics making the case for expansionary austerity (aka the 'confidence fairy') had much influence on the debate. The UK was the only country that had the required precondition (a big depreciation in the exchange rate) and even here exports failed to respond.
Much more important was the doctrinal belief that budget discipline was in itself a good thing, regardless of the phase of the cycle. Germany articulated this view with moral fervour, having extra authority as the only European country growing normally. In the US, this view was held far more widely than just within the Tea Party, but this tiny faction was effective not only in promoting the 'starve the beast' small-government narrative, but in making it politically impossible to repeat the 2009 stimulus. The succession of budgetary/debt confrontations have distracted the US from examining whether continuing austerity (which will take around 1.5% off growth over the next year or so) is appropriate.
In addition, too much faith was placed in the notion that monetary policy alone would do the job. Following the 2008 crisis, central banks swiftly lowered interest rates, which was doubtless very supportive of the economy, but once interest rates are close to zero, there is not much more that can be done.
Nevertheless, quantitative easing (QE) was added to the monetary policy arsenal. Nearly a decade ago, Japan demonstrated that QE has little or no impact beyond the psychological support it provides. The post-2008 rounds of QE may have helped stock markets and lowered exchange rates, but it is a feeble instrument. Now some are suggesting that an extreme version of QE should be used as a way of getting around the fiscal policy impasse. This is desperate last-resort policy advice. It would be better to say that monetary policy had done all it can sensibly do.
Austerity has made debt ratios worse rather than better. Growth forecasts are lacklustre for as far ahead as projections go. The politics in the peripheral European countries is barely holding together. Yet no-one is ready to change fiscal tack.
To advocate abandoning austerity would be too much of a back-down. The UK Government would have to admit that its policy had been 'courageous', in Sir Humphrey's terminology. The IMF has accepted that the fiscal multipliers used in earlier forecasts understate the contractionary impact of austerity, yet maintains its customary 'one the one hand...on the other' ambivalence. The latest G20 meeting did little to soften the targets set down at Toronto in 2010 to 'at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016.'
It would be easy to blame this on dysfunctional politics: bitter acrimony between Democrats and Republicans in the US, an overly-doctrinal approach in the UK (perhaps falsely comforted by Lady Thatcher's 'There Is No Alternative' legacy), and sharp differences of national philosophy in Europe.
But this lets economists off too lightly. Some asserted that the economy has strong self-equilibrating properties. Others wanted to blame balance sheet problems for the slow growth without also emphasising that fiscal expansion might still be appropriate. Some argued that the answer lay in structural issues, not the deficit. Others delved into the history of totally different economies to prove that debt levels were unsustainable just about everywhere, even though historically low bond yields have been signaling that the market was ready to fund bigger budget deficits.
If economists had offered a clear consensus prescription for restoring economic health, it would have been harder for the politicians (some with their own nutty economic ideas) to have dithered so much. Is it too late to ease the austerity?
Photo by Flickr user gabaus.