An alternative to rigid austerity
Current policy has been discredited in just about every way possible
It is almost too easy to dismiss the critics of austerity. The people who matter, the ones with the money, won’t lend it to anyone who doesn’t sign up to the doctrine. And there the argument rests: no cuts, no cash. Faced with this binding constraint, thoughtful people who might otherwise come up with sensible alternatives are left spluttering and, mostly, incoherent.
But austerity has been discredited in just about every way possible. Yet for those people who matter, it is still rigidly adhered to. The Troika continues to insist on it, albeit with an embarrassed IMF that doesn’t know how to get out of the hole that it has dug for itself. Our own Central Bank and Fiscal Advisory Council still demand that nothing changes. I can’t imagine that any of these institutions believes in expansionary austerity (if they ever did). So why still push a failed dogma? What is it about this particular dead horse that requires a repeated flogging?
My suspicion is that further tax rises and spending cuts are demanded here and elsewhere because a good crisis should never be allowed go to waste. This is the only chance to get governments to behave. Maybe that’s a touch cynical, certainly very undemocratic. Could there be good and logical reasons underlying the beliefs of the people that matter? If there are, I can’t figure them out.
There is a visceral fear that if profligate politicians are let loose, a new cycle of wasteful spending will be unleashed, a new debt binge will begin, with no lessons learned from the last crisis. Seen in this light, fiscal policy is a choice between austerity or binge. There is no middle way, no alternative at all.
Maybe it is believed there is no credible alternative, nothing other than austerity will enable bailed out countries to return to the international debt markets. Market credibility is certainly important. My sense is that not a single bond market investor out there thinks that current polices have a shred of credibility. While the crisis may have subsided there is, I think, a widely held view amongst market participants that the worst is yet to come. It may be years rather than months away but if the euro zone carries along its current path, further extreme crises are inevitable.
Let me suggest an alternative. I will label it ADOG: austerity dependent on growth. We, and any country participating in this new scheme will commit, perhaps via a new constitutional amendment, to tighten fiscal policy subject to economic growth. For every 3 percentage points of growth in GDP we will then, and only then, implement budget cuts worth 1% of GDP. These cuts will continue, if growth permits, until the budget is balanced at full employment (I will let others pronounce on just where that might be).
So, with the economy basically flatlining right now, no more budget adjustments. Of any kind. We wait for growth before the next budget. This has the pleasant side effect of cancelling the dreary annual budget cycle, a most unpleasant anachronism. We introduce a budget when growth allows. Whenever that might be.
Between now and then we do nothing. If the economy shrinks, we borrow more: this is called allowing automatic stabilisers to work. Who will lend this extra money to us? That’s the appeal of ADOG. Provided we have credibly committed to future austerity, bond investors, I believe, will be forthcoming. That’s why some kind of budgetary constitutional change will be necessary.
If the economy grows, we sit back in admiration until we see the magic 3% expansion figure. Then we do a bit more austerity - mandated by law. Any other kind of fiscal adjustment must be balanced: if somebody wants to raise expenditure of any kind, they have to raise taxes. And vice versa.
ADOG will be credible, much more so than current policies. Bond markets know that nothing is going to work without growth, so we might as well make all future policy adjustments dependent on growth. As practiced today, austerity is utterly self defeating: it provokes recession. At best, it stops the economy from growing. The markets are acutely aware of this. I think bond markets will love ADOG.