The global scourge of spending cuts and austerity
In a recent article in the New York Times [1,2], economist Paul Krugman made the point that “the widespread demand for austerity serves a political agenda, with panic over the alleged risks of deficits providing an excuse for cuts in social spending”. However considering the current state of the global economy, the budget deficits of sovereign governments present no risk of unacceptable inflationary pressures or rising interest rates whatsoever.
Indeed, many heterodox economists would go further, by saying that for any economy operating below full capacity its central government has nothing to fear by allowing its budget deficits and spending into the real economy to rise to whatever levels are necessary in order to secure healthy levels of aggregate demand and employment.
Krugman also made the point that in a non-inflationary environment budget deficits and government spending may be easily accommodated by allowing the central bank to make use of its ability to manufacture banking reserves (a form of state fiat money, or base money) out of nothing. This process is often described as “printing money”, even though it is fully recognized that no printing presses are involved in the manufacture of reserves. Here is his account:
“… there actually is a sure-fire way to fight deflation: When you print money, don’t use it to buy [financial] assets; use it to buy stuff. That is, run budget deficits paid for with the printing press.
” Deficit finance can be laundered, if you like, by issuing new debt while the central bank buys up old debt; in economic terms it makes no difference ”
One of the implications of this is that in a depressed, deflationary economy, conventional fiscal prudence is dangerous folly. In particular, the simplistic and misconceived notion that every surplus is good and every deficit is bad must be abandoned. This is relevant to the Australian economy, because some informed Australian and overseas commentators now predict [3-7] that Australia will soon move into recession. In such circumstances, to continue with austerity, with the objective of cutting federal budget deficits in order to achieve a surplus at some future time, would be tantamount to applying a wrecking ball to the economy. Clearly the opposite fiscal trajectory is needed.
Let’s hope the new Turnbull government is aware of what will be required
for ameliorating the effects of any tendency to recession, as was the Rudd government in the wake of the global financial crisis — as evidenced by its program of fiscal stimulus during 2008- 10, which (notwithstanding inadequate monitoring of some spending projects) served to keep recession away from Australia’s doorstep.