US success proves European disciples of austerity wrong

We've been living, over the past five years, through a giant open-air experiment. Two vast economic blocs, the European Union and the United States, faced the same problem: a banking crisis had turned into a profound economic recession. But the two blocs responded in strikingly different ways. The EU decided, as Angela Merkel put it in 2010, that "all members of the euro zone have to reduce their deficit with determination and great speed" – hence the policy of slash-and-burn austerity. The head of the European Central Bank, Jean-Claude Trichet, issued the sweeping command in 2010: "Stimulate no more, it is now time for all to tighten." The great binge had to be paid for with the great purge.

The US, on the other hand, had a mildly progressive president who went instead for a mild dose of economic stimulus. Barack Obama insisted that a deep recession was not the time to become obsessed with government deficits. It was the time to use the power of government spending to make up at least some of the fall in private economic activity. In 2009 he introduced a stimulus plan worth $831 billion, most of it spent over the following three years.

There is now real, living evidence against which to measure the sharply opposed claims of conservatives and progressives. A crucial part of that evidence is now in. Oddly enough, you have to look very hard for it in mainstream political discourse in Ireland and Europe. The experiment has shown that the claims of the deficit hawks – the ideas behind the dreadful suffering imposed on citizens in Ireland and elsewhere – are wrong.

European 'common sense'
The people who gave Ireland and Europe a one-way ticket to austerity told us Obama was deluded. By holding and even increasing public spending in the face of the recession he would create a disaster for the US. The budget deficit would balloon. Interest rates would rise and inflation would spin out of control. The US would do immense damage to itself and drag the world economy from recession into depression. This was the overwhelming "common sense" of Europe. More than that, it was written into EU law – we were all terrified into voting for a treaty that outlaws forever what Obama was doing. Increasing deficits during an economic crisis was so obviously insane that it had to be placed beyond debate.

In 2010, Wolfgang Schäuble, the German finance minister who provided the intellectual and political muscle for this policy, predicted disaster for the US: “They have already pumped an endless amount of money into the economy via taking on extremely high public debt and through a Fed policy that has already pumped a lot of money into the economy. The results are horrendous.”

US deficit decline
On Thursday last, the US Treasury published its figures on what actually happened to the US federal budget deficit in 2013. It didn't just fall – it fell spectacularly, from $1.1 trillion to $680 billion. That's the largest annual decline in the deficit since the end of the second World War. Progressives in the US argued that, if the economy could be prevented from going into freefall and if unemployment could be kept down, the deficit would largely take care of itself. This is what has happened. The deficit was 10 per cent of GDP at the depth of the recession – it's now 4.1 per cent. Why? Because modest economic growth has generated more tax revenue and allowed marginal tax rates to rise.

None of the “horrendous” consequences predicted by the austerity hawks has followed. US inflation is currently 1.6 per cent – if anything it’s too low. Interest rates didn’t spiral – they’re close to zero. The deficit rose in 2009 and has been falling ever since – last week’s figures suggest it will keep falling to 3 per cent. Our European masters have turned out to be clueless on the very questions of fiscal responsibility by which they have defined themselves.

This is not really very surprising. The International Monetary Fund admitted in 2012 that its basic assumptions were wrong and that austerity cut economic growth much more than it had expected. A second pillar of austerity – the Reinhart-Rogoff hypothesis that growth slows sharply when debt tops 90 per cent of GDP – turned out to be based on an analytical error. Euro-zone austerity was not really an economic idea at all. It was an essentially religious belief that sin must be atoned for with suffering.

Such beliefs are, sadly, impervious to evidence. The revelation that the sums were wrong made no difference. The fact that the results of the alternative policies followed in the US are the precise opposite of what our rulers predicted will be similarly ignored. True believers can’t be wrong. And they have been, after all, right about one thing: the suffering.