Saturday, April 27, 2013

Austerity. Why it is suddenly no longer fashionable

It’s been an appalling fortnight for peddlers of austerity. Bit by bit the weight of Australian and international opinion has shifted away from surplus towards deficit, away from repayment towards debt and away from containing inflation to rekindling it.

Australia contribution was startling. As recently as December opposition leader Tony Abbott was promising surpluses “in each year of the first term of a Coalition government,” although he qualified the promise by saying it was “based on the published figures”.

Last week he declared “all bets are off”.

"We were confident that we could deliver a surplus based on what the government was telling us until just before Christmas," he said. "But all bets are off given that the Government won't tell us what the deficit will be."

His treasury spokesman Joe Hockey fleshed things out. Enforced austerity at a time when the economy was fragile could send things pear-shaped.

“It is important to be prudent,” he told an investment conference. “We are not going to go down the path of austerity simply to bring the budget back to surplus, because it would end up being a temporary surplus depending on how deep the deficit is that we inherit.”

“The challenge will be how to get the settings right to bring the budget back to surplus, to start to pay down some of the government debt - whilst at the same time not constraining what I think will be a sense of optimism and hope if there is a change of government,” he said in further remarks not previously reported.

“I think companies will unleash their balance sheets, and I think consumers will as well if there is a change of government, and I am very mindful that we don’t want to be the ones that close down that optimism.”

The Coalition’s new caution about a swift return to surplus, coming months after the government’s embrace of caution, means there is now no mainstream political party promising to quickly end the deficits, or to quickly pay down the government debt they will pile up.

In January Hockey was committed to a surplus “to the core of my bones”. Events since have chilled those bones.

The Reserve Bank is worried there simply isn’t enough happening in the economy to take the place of mining investment as it turns down. The December quarter national accounts released in March showed machinery and equipment investment down 2.5 per cent. Hours worked slipped 0.1 per cent. Household spending climbed just 0.2 per cent.

The consumer price figures released Wednesday put March quarter seasonally-adjusted inflation at just 0.1 per cent. Businesses are having to discount to get Australians to spend. (Woolworths cut average prices 2.5 per cent in the quarter). The discounting is squeezing their profits and providing little reason to invest, at exactly the time the economy needs non-mining investment.

To further cut government spending at such a time could risk recession. Overseas the idea that government debt itself causes recession got hammered at about the same time as the Coalition’s rethink in Australia...

Internationally renowned economists Carmen Reinhart and Kenneth Rogoff became disciples of the austerity movement in 2010 when they published a provocative paper entitled “Growth in the Time of Debt”. They claimed to have discovered a tipping point. Government debt didn’t seem to do much harm until it reached 90 per cent of gross domestic product. But from that point economic growth crumbled.

“Even advanced economies hit a ceiling,” they wrote. “Current debt trajectories are a risk to long-term growth.”

Mitt Romney’s vice presidential running mate deployed their finding in campaigns. In Britain an advisor to David Cameron used it to back spending cuts which as it happened pushed the UK into recession. In mainland Europe it prodded already weak economies to cut spending further.

At the University of Massachusetts a graduate student had been having trouble with his homework. Thomas Herndon had been trying to replicate Reinhart and Rogoff’s findings. Eventually they gave him their spreadsheet and showed him how to use it. When he did he found glaring - almost inconceivable - errors.

In attempting to average 20 cells on their Excel spreadsheet they had only highlighted 15, leaving out the first five in the alphabet - Australia, Austria, Belgium, Canada and Denmark. And there was more. When he and his teachers recalculated the spreadsheet the tipping point disappeared. All that remained was a mild negative correlation between government debt and growth, one more likely to be the result of weak growth pushing up the debt ratio than other way around.

A laughing stock on US television all week and mocked more seriously by US economist Paul Krugman as the “coding error that destroyed the economies of the Western world,” the findings had carried weight in Australia. Just this week the Grattan Institute cited them in support of the proposition that high debt could slow economic growth “for a long time”.

Austerity for austerity’s sake is suddenly unfashionable. The Grattan Institute’s talk of a decade of deficits has become more of a forecast rather than a warning.

The Reserve Bank meets in ten days time, a week before the budget. It is increasingly concerned about the economy and it’s in no mood for austerity.

In today's Sydney Morning Herald

Related Posts

. The shocking truth about the IMF's misforecast

. Debt free. Got any other ideas to stifle growth?

Related Reading

. Did a coding error basically destroy the economies of the Western world?

. Forget Excel: This Was Reinhart and Rogoff's Biggest Mistake

. The Grad Student Who Took Down Reinhart And Rogoff

. Reinhart And Rogoff - We resent the attempt to impugn our academic integrity

. Krugman - While the austerity doctrine imploded, austerity strengthened its grip

. Krugman - Other austerity bloopers