When Austerity Works

Another day another tale from the austerity files. But progressives are well aware of the fact that fiscal austerity can be successful macroeconomic policy — that’s why we got the budget deals of 1990 and 1993, deals that have been repudiated by the mainstream American conservative movement but embraced by most liberals, and certainly by the brand of liberal who’s currently running the country.

But the conditions have to be right for this. As Paul Krugman says today “So yes, you can boost your economy with fiscal austerity, as long as you also devalue your currency and sharply reduce interest rates.”

Which is exactly why fiscal austerity has been a smart recession-response for small open economies with floating currencies. That’s your Iceland, your Israel, your New Zealand, etc. It’s also why austerity budgeting was the correct move in 1993 where it was part and parcel of an overall shift in policy toward lower interest rates and expansionary monetary policy. But this isn’t the situation facing the United States today. Or at a minimum the anti-austerity position is that this isn’t the situation facing the United States today. Ben Bernanke isn’t promising more aggressive monetary policy in response to fiscal retrenchment, and markets aren’t showing any sign that government borrowing is crowding out private investment. In the future, the projected deficit will definitely be a problem and we’ll definitely need to reduce expenditures on Medicare, defense, and Medicaid as well as closing loopholes, curbing tax subsidies, and raising revenues. But that’s not the situation now, and stinting on fiscal stimulus today doesn’t do anything to make it easier to control Medicaid tomorrow.