The Austerity Quandary

Even if we don’t go over the “fiscal cliff” at year’s end, the cries for governmental austerity will only grow louder. Some major measure of fear is understandable in that our federal debt and deficit problem is a big one that needs to be solved. Yet such austerity would be a real and immediate drag on our economy. 

Augustine famously prayed for chastity, just not yet (da mihi castitatem et continentiam, sed noli modo).  In much the same way, Fed Chairman Ben Bernanke warns that federal debt and deficits are a real problem.  Indeed, he gave a speech on the economy earlier this month and asked Congress to address the issue.  But he doesn’t want anything done quite yet:

I certainly don’t underestimate the challenges that fiscal policymakers face. They must find ways to put the federal budget on a sustainable path, but not so abruptly as to endanger the economic recovery in the near term.

Indeed, in Europe, heavy austerity seems to have crippled growth in countries like Spain and Greece. With unemployment near Great Depression levels and with middle-class workers reduced to picking through garbage in search of food, austerity arguably appears already to have gone too far.  The International Monetary Fund recently released a report conceding that tax hikes and spending cuts can inflict far more damage on weak economies than previously thought.  Pretty much everything that has happened economically since the general move from stimulus to austerity, from interest rates to inflation to output, has supported the idea that austerity hurts struggling economies.

On the face of it, these realities suggest that the proper policy approach is to withhold austerity and even to add more stimulus now while the economy is struggling and then, when the economy improves, to deal with the debt/deficit problem.  Unfortunately, as good as that theory might be, its execution is likely to be problematic at best.

The sad reality is that there is not a lick of evidence that our political leaders would have the strength and discipline required to impose austerity (which entails a great deal of political risk – stuff people want will have to be cut) when times are good and politicians desperately wish to bask in the glow of success.  I suspect that austerity will only be palatable and thus achievable in response to a perceived crisis, and a major one at that.  A healthier economy does not a crisis make.  Indeed, it won’t be seen as a crisis at all; it will be seen as a reward and yet another opportunity to open the piggy bank.

It’s a major quandary.  If we do what is almost surely the right thing in the aggregate, the overall problem is far less likely to be fixed and probably becomes much worse.  On the other hand (and ironically), doing the wrong thing by implementing austerity right away will probably provide the better overall result over time. 

But it won’t lessen the near-term pain.

2 thoughts on “The Austerity Quandary

  1. Sounds similar to the Prisoner’s Dilemma from game theory. From Wikipedia:

    The prisoner’s dilemma is a canonical example of a game analyzed in game theory that shows why two individuals might not cooperate, even if it appears that it is in their best interests to do so

    In casual usage, the label “prisoner’s dilemma” may be applied to situations not strictly matching the formal criteria of the classic or iterative games: for instance, those in which two entities could gain important benefits from cooperating or suffer from the failure to do so, but find it merely difficult or expensive, not necessarily impossible, to coordinate their activities to achieve cooperation.

  2. Pingback: Prep Updates 10/25/12 |

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