After Austerity

Evan Soltas is a contributor to Bloomberg View.
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The high tide for Keynesian fiscal stimulus came in 2008 and 2009. Panicked governments spent, spent and spent to stem the financial crisis and avoid a depression. But as economies stabilized in 2010 and 2011, governments began to worry about public debt. Enter the austerians. They pressed for fiscal consolidation -- and got their way. One has to look back to the 1940s and 1950s, as nations demobilized from World War II and the Korean War, to see a comparably rapid tightening.

Now, though, the intellectual case for austerity is on its way out -- at least in its vulgar form of immediate cuts to public spending and sharp increases in taxes. Part of the change comes from the implosion of a central claim in an academic paper by Harvard economists Carmen Reinhart and Kenneth Rogoff. They found that nations stop growing when their ratio of public debt to gross domestic product passes a threshold of 90 percent. Their findings were exhibit A for advocates of austerity.

Their claim has now been debunked by new analyses finding calculation errors, data omissions, questionable methods and inconclusive evidence of causality. Other high-profile arguments for austerity -- such as recent papers by Alberto Alesina and Silvia Ardagna, and by David Greenlaw and three others -- have also been criticized.

The case for austerity is coming apart for another and more important reason: The results are in, and they're terrible, especially where central banks have failed to offset the fiscal cuts with monetary easing. The International Monetary Fund called for less austerity in a meeting last week. Among the Group of 20 nations, many governments have eased their targets for debt reduction and called for new efforts to boost growth.

What comes next, however, isn't clear. Don't expect a clean break. Some austerity is already locked in: Gradual fiscal tightening will occur as recovery dampens "automatic stabilizers" such as unemployment insurance and food stamps. Aside from that, fiscal policy could move in any of several directions.

Longer-term issues might come to the fore. How can we best restructure social-insurance programs like Medicare, Medicaid and Social Security? How can we best reduce spending on defense programs? How can we best raise new tax revenue? Washington will probably do some modest long-term tightening, especially where partisan fervor is less intense -- on corporate tax reform, for instance. But don't expect much more.

Here's another possibility: Attention might turn back to monetary policy. That would make sense, because the evidence suggests that central banks have mattered much more than treasuries in influencing the depth of the recession and the pace of recovery. If aggregate demand is the problem -- and in the U.S., Europe and Japan, there's every sign of it -- then one solution is to adopt a monetary-policy rule that returns nominal income to its pre-recession growth path. That's something Congress could tell the Federal Reserve to do -- revising the mandate it laid down in 1978. Japan is already talking monetary policy. Europe will be forced to soon.

Maybe political debate will focus on other subjects altogether. The rise of new issues -- such as gun control, immigration, and gay marriage -- may crowd out a fiscal battle fought to stalemate. At least in the U.S., this might even be a good thing. Putting the budget on autopilot for a while -- and dealing with questions that were sidelined during years of fiscal monomania -- might be the best result.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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Evan Soltas at