The sound (finance) and the fury

Matías Vernengo

The current policy consensus in the developed world (i.e. the United States and Europe) seems to be that fiscal austerity (the euphemism used these days is consolidation) is necessary.  Christine Lagarde, the new Managing Director of the International Monetary Fund (IMF), said recently in the Financial Times that: “fiscal adjustment must resolve the conundrum of being neither too fast nor too slow.”

That is what she refers to as “Goldilocks fiscal consolidation,” that is, cut spending and increase taxes, but slowly please!  She repeated this view in her talk at the Jackson Hole conference, arguing that in order to obtain “credible” consolidation governments must implement: “measures that change the rate of growth of entitlements, health or retirement.”  In other words, cut spending and increase taxes fundamentally on social programs that benefit overwhelmingly the poor.

This simply misses the point of everything we do know about fiscal consolidations, and insists on the myth of expansionary fiscal contractions [Lagarde does not bother to say what is the mechanism by which fiscal contraction would lead to demand expansion, but it must be a variation of what Paul Krugman calls the ‘confidence fairy’].  Cutting spending and increasing taxes would reduce the level of activity and reduce revenue,  increasing deficits and debt, and as growth slows down, jacking up debt-to-GDP ratios.  In other words, fiscal austerity makes the consolidation of fiscal accounts more difficult.

Note that fiscal consolidation is being used, in the United States and in Europe, to promote a set of policies that have little to do with the short-run concerns with unemployment, and a lot to do with the long-term agenda of what the State should do, and what type of society we want to live in.  The economic model in the US and Europe has been based on stagnant wages and economic growth associated with bubbles, in the US a consumer bubble, and in Europe a bubble in the periphery that allowed Germany to rely on export-led growth.  In both cases, the rich and the financial sector had done well while workers have struggled.

Now that the system has been shown to be unsustainable, and once governments bailed out the financial sector, rather than guarantee that another crisis cannot occur by imposing severe restrictions on financial speculators, cuts in social spending are being imposed in both the US and Europe.  The elites in developed countries are certainly not letting this crisis go to waste.  In the US a few Republicans want to raise taxes, but on the poor! A financial crisis caused by the excessive borrowing of the private sector has been transformed into an opportunity to roll back the Welfare State.

In Europe Angela Merkel and Nicolas Sarkozy not only declined to support the issuing of Eurobonds, which would reduce significantly the interest costs for the periphery, but also pressed for tougher deficit rules for peripheral countries.  In Spain the Socialists and the opposition will impose a constitutional rule to limit deficits and debt, something that did not work in Argentina (the so-called zero deficit law in the late stages of the crisis).  In the US the bipartisan deal to extend the debt ceiling will most likely include cuts on social programs like Medicare and Social Security.  Cuts in public sector workers salaries, extension of retirement age, reduction of benefits, and privatization, all mantras of the failed neoliberal policies are back in the agenda.

But worse than the commitment to failing policies, is the inexplicable lack of concern with the social and political consequences of these economic policies.  Politicians should not be surprised with the fury of the streets, be that of the Spanish “Indignados,” the public workers in Wisconsin or even of the less coherent Tea Party, or more frighteningly of the irrational shooter in Norway.  The 1930s saw the rise of progressive alternatives to reduce the instability of capitalism, as Keynes and other moderate reformists wanted, but also the rise of fascism and horrific social violence.  If the political elites in the United States and Europe do not reverse course on sound finance, the fury in the streets will get increasingly out of control.  Economic policy these days is increasingly, as the bard suggested, a tale told by an idiot full of sound and fury signifying nothing.