Austerity and Unemployment
April 22, 2013
Austerity causes economic contractions that increase unemployment, as shown in the European economies of late:
The contrary view—that cutting spending magically inspires private demand and positive supply shocks—doesn't seem to be working out so well. Why should business invest when capacity utilization is so low?
For the U.S., capacity utilization plummeted in the Great Recession and although recovering, is still below its pre-recession average of about 81.5 percent.
I remember struggling and deeply digesting the Keynesian IS/LM framework my junior and senior years in college. The four-quadrant diagrams were enough to make my future wife abandon economics for business, but for myself, I was deeply invested. Living through a liquidity trap in the present has been a fascinating experience from a purely intellectual standpoint.
From a human and ethical standpoint, living through a liquidity trap when half the macro-economics profession eschews the basic Keynesian IS/LM framework is deeply depressing because it suggests that much unemployment and the concomitant human suffering is unnecessary. Applying leeches to a patient or bleeding the patient may inspire confidence that one is taking the necessary hard medicine and behaving virtuously, but there is no guarantee that such half-baked ideas will magically work. They usually do not.
Economics does not progress in a linear fashion, but rather recursively. We plow forward with the new and throw out the old that we think is irrelevant. We later come back to revisit what we threw out that turned out to be important. That is why interest in Adam Smith has been flourishing after perhaps a century of neglect. The same story may one day be true of Keynes.
POSTSCRIPT: Let's not forget the half-baked Keynesianism as well—the erroneous idea that Keynes called for big government in general. Keynes was clear (see last chapter to The General Theory) that when the economy recovers to full employment the fiscal budget needs to move toward a surplus.
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