Navigating challenging economic waters

Down south, the Obama administration is in a dangerous game of chicken with Republican congressional leaders, who are cynically holding the US economy hostage in order to impose a radical agenda of spending cuts. Obama has seemingly bought into the rhetoric of cutting debt, rather than focusing on the real US problem of unemployment. Yet, even his foolish offer to make cuts to Social Security and Medicare as part of a deal to raise the debt ceiling have been rejected by the Republicans (military spending cuts are off limits to them as are any tax increases).

Having caved on extending the Bush upper-income tax cuts last year, the Republicans are betting Obama will cave again. Let’s hope he doesn’t because the biggest threat facing the global economy right now is that self-inflicted austerity programs implemented in Canada, the US, the EU and elsewhere push us back into recession, and that would increase unemployment and further deepen financial problems.

At heart is the faulty premise that fiscal austerity is needed in order to shore up business confidence so that they will invest and thus grow the economy. Paul Krugman calls this the “confidence fairy” and it is clear from case after case worldwide that there is no such fairy. Austerity in the midst of an economic downturn makes things worse by undermining employment and the economy, worsening not improving the government’s fiscal situation. It is the modern equivalent of human sacrifice.

Joseph Stiglitz remarks:

Regrettably, the financial markets and right-wing economists have gotten the problem exactly backwards: they believe that austerity produces confidence, and that confidence will produce growth. But austerity undermines growth, worsening the government’s fiscal position, or at least yielding less improvement than austerity’s advocates promise. On both counts, confidence is undermined, and a downward spiral is set in motion.

In the case of both Stiglitz and Krugman, it is nice to seem them sticking to solid Keynesian economics when so many business commentators and politicians have abandoned economic reality. It is a key role of government to stimulate the economy when it is depressed, and that means more effort at job creation not less. The biggest mental error I see out there is the notion that governments are like households and must tighten their belts, which is precisely the wrong way of thinking about things in macroeconomic terms.

In the case of the US, part of the problem is that Obama was not stimulative enough, with fiscal policy consisting largely of tax cuts (a weak stimulus particularly when aimed at the wealthy) and aid to the states (which is necessarily to plug holes but not truly stimulative). One result of tax cuts is that they have simply padded the coffers of big corporations. Like in Canada, US corporations are sitting on a hoard of cash — investment is not happening because it is customers that are lacking, not confidence.

Some historical context is needed, too. The Bush era tax cuts and spending to wage war converted budget surpluses a decade ago into the baseline deficits heading into the recession. Republicans seemed to have no qualms about rising debt back then. The US economy is still fragile with high unemployment and the lingering fallout of the housing bubble collapse. Deficits and extraordinary monetary policy have averted an outright depression, but at the moment any lessons from the financial crisis of a couple years ago have been lost to a resurgence free market fundamentalism.

What’s this mean moving forward? Keeping up the stimulus is a top priority, and even leaning more heavily into job creation would be advised. If deficits are of concern, then increase corporate taxes and income taxes on the wealthy. Engage mortgage relief to the millions of US households who are underwater. But don’t buy into the doom and gloom stories about default. While it is true that a default would be uncharted territory, constitutionally, US debt is backed by law. The US issues debt in a currency it controls, and the Fed could play a major role by buying up some of the outstanding debt for cash. But ultimately, as James Galbraith points out, the big holder of US debt is China and it does not really have anywhere else to go to park its money (some gold, Swiss francs and some Canadian dollars on the margin perhaps).

For Canada, this means we need to keep our cool, and NOT play the austerity game revealed in last month’s budget. Piling on with spending cuts and layoffs will only make things worse. Federally and provincially, governments need to focus on employment not deficits in order to maintain robust demand in the economy (climate action is a great place to start). The Bank of Canada also needs to reconsider murmurings of interest rate increases this fall in light of these developments. Our biggest risk is that we harm ourselves to save a summary statistic rather than focus on the real challenges.


  • “In the case of both Stiglitz and Krugman, it is nice to seem them sticking to solid Keynesian economics when so many business commentators and politicians have abandoned economic reality.”

    It would be more accurate to say “sticking to solid neoclassical synthesis economics” (although it is also somewhat of a misnomer to lump Stiglitz and Krugman together). Keynes viewed the fiscal stimulus strategy as a medium-term measure, whose effectiveness would wane over time as additional investment became “wasteful and unnecessary.” To the quantitatively-inclined adherents of the neoclassical synthesis, there could be no such thing as wasteful or unnecessary growth.

    Publishers’ Weekly has recently named David Batker’s and John DeGraaf’s forthcoming book, “What’s the Economy for, Anyway? Why It’s Time to Stop Chasing Growth and Start Pursuing Happiness” one of its top ten Business and Economics books for fall 2011.

    It is a serious mistake to conflate “stimulating the economy” with job creation. Both financial markets and government programs have evolved over the past 30 years to ensure that a disproportionate amount of any fiscal stimulus will get siphoned off in the form of higher corporate profits, not wages and employment. Trying to create jobs by boosting growth is like trying to fill up a bucket that has a big hole in it. Any programs to create jobs would have to be distinctly targeted to directly create jobs and not rely on the the now anachronistic link between growth and jobs.

  • It’s important to note that Keynes’ 1930’s advice was not directed to countries that were already deeply indebted. The current troubles of Greece, Ireland, Iceland, etc. show that it’s tough to follow the Keynesian script when creditors have already concluded that you’re not likely to pay them back.

  • Hey Sandwichman, did you see Kingwell’s piece on capitalism and work in the latest Harper’s? I thought of you when I read it.

    Keynes’ core concept was “effective demand” and that is what we are talking about here.

    RCP, we’re probably looking at defaults that give private investors a haircut in the cases of Greece, Italy etc.

  • Debt is not really relevant to Keynes’ 1930s advice. If you have a certain kind of recession, the way to get out of it is to stimulate demand. If you start with a little debt, you’ll get out of it with a little more; if you start with a lot of debt, you’ll get out of it with a little more–but either way it’s better than not getting out of it.

    Interesting how rcp lumps Greece, Ireland and Iceland together as if they were all in the same boat and had made the same choices. In fact, Iceland is doing rather better than Greece or Ireland, and it’s because they told the IMF et al. to sod off.

  • Marc,

    No, I didn’t see it (Kingwell in Harper’s). Thanks for the tip!

    Keynes did indeed focus on effective demand but he also anticipated a time when the investment that fiscal stimulus could generate would be wasteful and unnecessary. Towards the end of WWII he estimated that such a time might arrive as soon as 15 years after the end of the war. As rep points out, when Keynes gave his advice in the 1930s, he certainly wasn’t addressing governments that had been running up debt for a generation.

    This is not to say that I am opposed to any and all stimulus spending. Just to say that not all such spending will create a commensurate amount of jobs. Dean Baker, for example, advocates a spending program that directly ties into job creation. That’s what’s needed, not a generalized “turn on the taps”.

  • P.S. I like the way Pierre Larrouturou puts it. He says we are at the end of a system of debt and debt-fueled growth will not return. Forget about growth: “There is only one way out of the global crisis: social justice.”

    La crise est financière mais avant tout sociale. Depuis Reagan, on a dérégulé, on a fait pencher le balancier vers les actionnaires au détriment des salariés, ceux-ci compensant par l’emprunt. Du coup, depuis quarante ans et dans tous les pays occidentaux, la croissance se fait avec de la dette. Il s’agit donc bien d’une crise sociale. L’erreur dramatique, c’est de prétendre que la justice sociale est un luxe auquel il faut renoncer à cause de la crise. C’est tout le contraire ! Le seul moyen de sortir de la crise, c’est de reconstruire la justice sociale.

  • If anyone seriously believes that the amount of debt that a government has does not seriously constrain its policy choices, I invite them to look again at Greece, Ireland, Iceland, etc. Italy may be next up, followed by the United States.

    Keynes was advising countries that were still on (perhaps not entirely faithfully) the gold standard. His advice might need some tweaking today.

  • Nonsense. The amount of debt the government has, has little to do with the policy choices difficulties of most of those countries, which in any case all have quite different difficulties even though the IMF policy prescriptions have been the same. Also suffering under the same policy prescriptions is Spain, whose problems have nothing to do with debt (well, arguably debt has a little bit to do with their problems–but only in the sense that even a moderate debt becomes onerous if your interest costs go from 3% to 20% or something due to opportunistic speculative attacks).

    First of all, for both Ireland and Greece a major portion of their policy problems can be traced to using a currency the government does not control. Now that seriously constrains policy choices.

    Iceland doesn’t really have major constraints on its economic policies that I’m aware of, nor does it have a particularly large government debt. What it has, like Ireland, is political problems and some economic difficulties traceable to a huge private sector debt. In the case of Ireland, the government was so stupid and so badly captured by certain elite groups that the government elected to take on that private sector debt. So the government now does have a large debt, and more importantly that debt is denominated in a currency the government does not control. Nonetheless, the constraints on its policy options are largely political rather than economic.

    Even the constraints on Greece’s policy options have more to do with speculative attacks on its currency and bonds, driving up its interest rates, than with the actual level of its national debt, which is not really particularly crushing. And, again, mainly on the fact that they’re using the Euro rather than something like a Drachma. But the real factors impacting their policy options are political–pressure from the IMF, bigger EU countries, banks and so forth.

    As to the gold standard, surely Keynes’ policies would work much worse, not better, for countries on the gold standard.

    Sandwichman, to some extent I think we’re talking at cross purposes rather than arguing. I certainly am not claiming that many of the policies that have been called “stimulus” are a particularly good idea or particularly useful for getting out of depressions. Direct job creation is definitely the way to go. Even Bernanke’s flippant “dropping money out of helicopters” would be a much more useful stimulus than many of the measures Obama and Bernanke have actually taken. I also think that whatever their theoretical differences, it’s generally agreed both by Keynes and modern economists like Krugman and Stiglitz that Keynesian depression-fighting measures should be temporary, although I’m not clear that they are likely to cause serious problems until they actually work in the sense of triggering broader demand-led economic growth. As to economic growth versus job creation, it’s certainly true that “economic growth” of late years has been decoupled from job creation, but it seems to me more like an accounting trick than anything else. It’s like the claim on the wealth in our economy is divided between the results of productive efforts on one hand, and manipulation of paper/electrons on the other, but it’s all represented by the same currencies. Of late decades, the paper-manipulators have found all these ways of growing the apparent amount of dollars their stuff represents. So the total amount of dollars gets bigger even if the amount of stuff being claimed doesn’t, or not nearly as much. Then this gets called “economic growth”, but all it means is that paper-manipulators have a bigger proportion of the claims on the available stuff, not that anything real you could use has actually “grown”. Sure, the world’s capacity to make widgets and deliver services may have grown, but not nearly as fast as “economic growth”; “economic growth” has become in good part a con game in many parts of the world (especially when you factor in externality costs like environmental destruction).

    Finally, I do agree that there are broader problems in the modern world economy than can ultimately be dealt with through Keynesian stimulus. But for a leader of a country hit by high unemployment in the immediate term, what they still need to do is create jobs rather than impose “austerity”. And while I’d like to think Pierre Larrouturou is right, I am not confident. The capitalists lurch from crisis to crisis, and it’s true that the current one which never really went away is the culmination of a decades-long series of short-term fixes which just stored up trouble, nonetheless the track record suggests they’re very good at finding one more fix. Social justice is something that needs to be taken whether the elites can finagle their way out of the current crisis or not.

  • @PLG:

    1) I agree that debt denominated in a currency controlled by the debtor country is less of a problem than debt denominated in a foreign currency, since devaluation provides a softer option than outright default. I don’t think anyone has disputed that, and it is in fact the reason that the Euro zone is currently in crisis. The “let’s pay them back in devalued drachmas” alternative is not currently available to Greece., for example

    2) I agree that Ireland, in particular, was foolish to take on debt to bail out Irish banks. Nonetheless they did it, and Ireland’s rating has been cut to junk today.

    3) Greece’s debt-to-GDP ratio is closing in on 150%, which I would describe as high, given that as part of the formation of the Euro zone the joining countries committed to keep the ratio at 60% or less.

    4) Blaming speculators for high interest rates is shooting the messenger, i.e. the bond market. The underlying mechanism is that an increased probability of default drives bond prices down, and hence interest rates up.

    5) All of these considerations lead to the conclusion that debt can constrain the policy choices available. A smaller debt means less constraint. Starting from zero debt, lots of Keynesian stimulus can be applied. Starting from close-to-default, much less Keynesian stimulus can be applied.

    All of this is pretty obvious, but if you’re in doubt that debt can affect policy you might want to read


  • Comment from Purple Library Guy : “Even the constraints on Greece’s policy options have more to do with speculative attacks on its currency and bonds, driving up its interest rates, than with the actual level of its national debt, which is not really particularly crushing.

    That’s hilarious. While I agree with him that austerity is not really the thing for the US right at the moment, Krugman is bad enough in ignoring or denying the possibility that the US, the UK, or even Japan could rather quickly get into similar trouble with too much debt if their governments get things wrong and the unique advantages that have allowed them to issue this much debt with such remarkably low rates are eroded too much. But to think that someone could go to such extreme lengths in a similar direction as to believe that even in Greece the problem is really something else is a bit shocking. Are the rating agencies also just “speculators” when they call it junk? No, whatever else you might say about the situation, Greece deserves its credit rating.

    Actually even Krugman said as much in his speech I watched on CPAC this morning, though he mentioned it only to say that the other Euro countries until very recently hadn’t really been as bad in their direct excessive government borrowing as has Greece for some years.

    Time for austerity in Canada? Obviously not. In the US? Probably not yet. In Greece? Well… not too many other options look much better to me; it’s debateable whether default would be any less painful than trying to keep up the payments. There is certainly a lot of that debate going on, and neither side seems all that convincing to me.

    The argument that so-called austerity will “shore up business confidence so that they will invest and thus grow the economy” seems to be a US republican thing. If I hadn’t heard some of them going on about it, I’d think its presence in the article here was a straw man. In most of the world, I think that is not really considered, the concern is more simply “fiscal austerity before we end up like Greece”. Which is probably a good thing to keep in mind, though it’s always difficult to judge how much room there is before you get there, and especially so when things are so weird as they are for example in the China/US relationship.

  • “Are the rating agencies also just “speculators” when they call it junk?”

    After their culpability in the subprime mortgage crisis, it is very possible they are part of the conspiracy.

  • Purple Library Guy: “economic growth” has become in good part a con game in many parts of the world…

    That’s basically what I’m arguing, too. The other side of the coin is that “austerity” is NO LESS of a con game. It’s even CALLED a “con” game by its advocates! Reducing government expenditures is advocated on the grounds that it will bolster business confidence.

    The humpty-dumpty of stimulus and austerity are in reality two sides of the same, capitalist, coin, neither of which address the problem, which is the growing inequity in the distribution of income.

    I’m not dogmatically opposed to any and all growth. I’m simply arguing that unless the priority is social justice, “stimulating the economy” will be just pouring more money down a well-lubricated rat hole.

  • Sandwichman wrote: “I’m simply arguing that unless the priority is social justice, “stimulating the economy” will be just pouring more money down a well-lubricated rat hole.”

    Agreed and we would do well to remember that neoliberalism was originally sold as the pro-growth formula. But one of the key underlying memes was restoring discipline and in that austerity as stimulus is true to ideological form: workers must now be punished because they borrowed too much both collectively and individually. Order must be restored!

    No matter that those and their system which caused the crisis are running wild in the streets.

  • rcp:
    Your point 5 applies to countries that do not have their own free-floating currency.

  • @keith newman:

    Point 5 definitely applies to countries that don’t have their own free-floating currencies, but applies more broadly as well. You can work a devaluation shell game within your own territory until the people get wise.

    Zimbabwe is a case in point:


  • Zimbabwe is a really bad example. Nobody is proposing that Greece ought to redistribute vast swaths of their productive land via a chaotic process which provokes a near civil war environment, tank their export capacity and then print Drachmas like there is no tomorrow.

    Japan is at over 200% GDP and it can still borrow really cheaply and there is no sign of increasing inflation. So the real questions are which countries can get away with high debt to GDP ratios, which cannot and why?

  • Travis, you are right that Japan is an outlier in terms of debt to GDP. I have often wondered about that. It seems intuitively that it might have something to do with aging demographics and risk aversion, but I haven’t seen anything that ties it up and puts a bow on it.

  • “The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance” (Look at the US, wink wink who is dooing all three with no end in sight – with fiscal crisis, and dollar crisis in the making)

    Keynes went on to say in “1940, [argued] that the war effort should be largely financed by higher taxation and especially by compulsory saving (essentially workers loaning money to the government), rather than deficit spending, in order to avoid inflation”

    I find it very funny. RCP is correct, Keynes was not an advocate for debtors such as wimar germany or the US or Greece to ramp up deficits.

    The US will have to restructure its debt where creditors also get a haircut. Greece should default on its creditors.

    Keyne central idea was the Bancor.

    This newly created currency would then be used in international trade as a unit of account within a multilateral barter clearing system – the International Clearing Union – which would also have to be founded – in where countries that have huge surplusses would be taxed to create an equal balance of trade – where in debtors like the Greence and US would be taxed to create an equal balance of trade.

    The Bancor was to be backed by commoditties including its value expressed in weight of gold.

    PLG, given this context, how would Keynes advocate if you start with a lot of debt, you’ll get out of it with a little more. Given he publicly denouced Wimar Germay 1930s. Germany held a lot of debt – by historical standards at that time – they did not get out of it by massivly pumping the pump.

    Price increases in Canada and the US have been outstripping wages and income. None of you have seen an unemployment problem created by inflation where people simply quit working because they refuse to work for wages that will not increasingly purchase an education, food, clothing etc.

    Keynes did!!!

  • rcp @ 6:36pm:
    Fair enough. I amend my comment. Your point 5 applies to countries that do not have their own free-floating currencies and are not in the midst of civil or other war, or have not experienced partial or complete economic collapse.

  • @ keith:
    Which neatly begs the question of whether running the printing presses long enough will lead to economic collapse…

  • “We’ve been obsessing over the last couple of weeks about raising the debt ceiling and reducing the debt and deficit,” Obama said. “I’ll tell you what the American people are obsessing about right now is that unemployment is still way too high and too many folks’ homes are still underwater, and prices of things that they need, not just that they want, are going up a lot faster than their paychecks are if they’ve got a job.” (includes

Leave a Reply

Your email address will not be published. Required fields are marked *