The Austerity Fairy

by Russ Roberts on May 11, 2012

in Stimulus

Paul Krugman explains why spending increases or mild spending cuts are really forms of austerity:

…some people who should know better are conceding the point that maybe there haven’t been big spending cuts. Yes, there have.

For the fact is that you can’t just look at spending levels to ask what is happening to spending programs. Here in the United States spending on unemployment insurance and food stamps has risen sharply, not because the welfare state has expanded, but because a lot more people are unemployed and poor. Similar effects are at work in European countries, which have stronger safety nets than we do. Also, some spending represents banking bailouts, not exactly what people have in mind when they talk about big government.

I get it. An increase in spending that doesn’t reflect a desire for bigger government but instead reflects automatic stabilizers, say–well, that’s not a spending increase. It’s the intention that counts when you evaluate the impact on aggregate demand. Krugman continues:

So let’s take a look at the example of Ireland. (All data from OECD). Here’s total spending in millions of euros, which might look as if there’s not much austerity.

 

 

 

 

 

 

 

 

No, it doesn’t look like there’s much austerity, does it? That’s why I wrote this post. Silly me. I didn’t realize that in the Keynesian model it isn’t government spending that affects aggregate demand, but only certain kinds of government spending. Krugman goes on to show that much of the increase in spending in Ireland is due to bank bailouts and increases in transfers because of the “dire state of the Irish economy.” But I thought those transfers were supposed to stimulate the economy. Joseph Stiglitz taught me that it doesn’t matter what government spends money on, it’s all stimulus. And when Krugman was touting a two trillion stimulus package, I don’t remember hearing the part about making sure it was pushed through with the right kind of spending and the right kinds of motives. Who knew that government spending only stimulates when it springs from a desire for bigger government?

You can go read the rest of the charts in his post. But it’s straightforward–some kinds of government spending were slashed. Therefore, even though the total amount of spending is roughly the same as in 2009, that’s austerity.

Just a few days ago, Krugman was arguing that Europe had tried slashing spending and that we now know that that didn’t work. Now he’s admitting that spending wasn’t slashed but that it really was, even though you can’t see it. You just have to know where to look. This is the man who likes to say the confidence fairy doesn’t exist. I’m afraid it’s the austerity fairy that doesn’t exist.

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