Which “austerity”? Fiscal or monetary?

Matt O´Brien has gone over to the “dark side” writing “Why is the recovery so weak? It’s the austerity, stupid.”:

Welcome to Austerity U.S.A., where the deficit is back below 3 percent of GDP and growth is still disappointing—which aren’t unrelated facts.

It started when the stimulus ran out. Then state and local governments had to balance their budgets amidst a still-weak economy. And finally, there was the debt ceiling deal with its staggered $2.1 trillion of cuts over the next decade. Add it all up, and there’s been a big fiscal tightening the past few years, something like 4 percent of potential GDP. Indeed, as Paul Krugman points out, real government spending per capita has been falling faster now than any time since the Korean War demobilization.

And, as you can see above, all this austerity has been hurting GDP growth since 2011. It shows the Hutchins Center’s new “fiscal impact measure,” which looks at how much total government tax-and-spending decisions have helped or harmed growth. The dark blue line is what policy has actually done, and the light blue one is what a neutral policy would have done. So, in other words, if the dark blue line is below the light blue one, like it has the last three years, then policy has subtracted from growth.

The chart shown:

OBriens Austerity_1

Interestingly, all the fiscal expansion during the recession (07/12-06/09) did not help. Real output growth tumbled and that´s because monetary policy was strongly contractionary. The “monetary austerity” is illustrated in the sequence of charts below:

OBriens Austerity_2

And since 2011, despite “fiscal austerity” the economy is growing by as much as monetary policy allows it to do!

8 thoughts on “Which “austerity”? Fiscal or monetary?

  1. I saw that article, yes, I agree, very disappointing. Particularly since O’Brien has written a lot of great stuff in the past.

    Krugman and O’Brien are really causing harm by talking about government spending / austerity so much. Monetary policy is so so so so so so much more critical, particularly in the short-term.

    • Travis, right! And I love this 1997 quote from Krugman, when he was “monetarist”:
      “… Indeed, if you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God…”

  2. I am inclined to agree with Sumner that if the Obama stimulus hadn’t passed, then the Fed would have made up for that. In fact, in that counterfactual scenario without the Obama stimulus, there’s a good chance that the U.S. unemployment rate would have fallen twice as fast as it actually did from 2010 to 2012.

    Other counterfactuals: what if McCain or Romney had been elected in 2008 / 2012? The other day, I discussed that with Bonnie Carr in the comments section of her blog:



    • Travis, The irony is that maybe, because of the 2009 FS, monetary policy was overly tight! Counterfactual: Without the FS monetary policy would have been expansionary and the recession “not great”!

  3. you have to explain how you would ease monetary policy at 0 policy rate.

    Everyone knows monetary policy works when rates can be lowered.

    Strange post.

  4. Pingback: Which “austerity”? Fiscal or monetary? | The Corner

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