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Why is that idiot Osbo continuing with austerity when we know it doesn't work?

No one told us we could do that!

Worstall @ the Weekend That austerity doesn't make the economy grow, is one of those things we all know to be true. And yet we've also got a government insisting that a recession, when there's spare capacity and we'd really rather like the economy to grow, is a great time to be cutting government spending and thus instituting that austerity.

This really doesn't sound all that clever and, while the Tories are known as the stupid party, there's got to be something more to it than that, right?

The answer being that yes, of course, there's something more than that going on.

A part of it is what we discussed back here. That there are those who want a smaller state and any old reason will do to have one. Then there's the other side of that argument, who don't, and any old argument will do there as well.

So, don't have austerity, don't cut government spending, because we should have stimulus in a recession. To which standard Keynesian economics leaves pretty much no response. But obviously there is one because this is what the government is doing. So what has it cobbled together in order to justify said cuts?

OK, so far at least, the cuts have just been lower rises than were previously planned for, it's the next round that are likely to be real cuts in real amounts of spending. But there actually is a justification for doing this. You don't have to agree with it, certainly, but the fact is that this has been tried before and it did work.

And our historical example is from the UK too, something the anti-cuts hysterics tend not to mention.

Here's two pieces laying out that anti-cuts argument. Simon Wren Lewis from Oxford and Paul Krugman himself.

Do note that there's nothing in the slightest bit odd about the arguments they're putting forward. This is entirely conventional economic wisdom. In a recession, cutting government expenditure will reduce the size of the economy. However, this isn't what we want to happen. In which case, don't cut expenditure in a recession.

Well, D'Oh!

They're also entirely correct that one of the arguments used to defend such cuts doesn't really hold up. That the yawning deficit, the climbing to the stratosphere of the national debt doesn't require cuts in order to restore “confidence”, at least not at the sort of levels that we've got in the UK (Greece perhaps being another matter).

There's also a second line of argument which also doesn't quite add up. Which is that fiscal stimulus itself doesn't really work because of Ricardian Equivalence. This is the idea that there's no point in borrowing money to boost the economy because everyone in it will be able to see what you're doing. They will thus save the money they know they will need to meet the future tax bill to pay for that borrowing.

That's what Ricardian Equivalence means. The problem there is that RE is true for all of us some of the time, some small number of us all the time but almost certainly not for enough of us enough of the time for it to be entirely true at the level of the whole economy.

In fact, one of the nice little mini-experiments that the recent troubles have contained shows this to us. Sending out stimulus cheques in the US (George Bush essentially saying, send everyone cheques for dollars as a method of stimulus) did work. But it was noted that if people were sent one for a few hundred, or a reasonable portion of a thousand or so, then they would indeed save it, use it to pay down debt, and that's not stimulative activity.

But if they got smaller amounts, even if they got them more regularly and amounting to the same total, they were more likely to spend them. This isn't exactly RE but it's the same general ball park. Enough people do spend that stimulus works even if it's not 100 per cent effective.

So, what's the great mystery? How can anyone start advocating “expansionary austerity” with a straight face? The answer being that it has been tried before and it worked.

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