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Austerity: Bite the Bullet

 

Austerity

Forget the F-word. Some influential politicians and economists are trying to prevent a new, unfathomable term from seeing the light of day. Austerity. Armed with an arsenal of Keynesian economics and horror stories from the Great Depression, these people are desperately trying to convince us that it is ok to run enormous fiscal deficits and assume unmanageable quantities of debt. Here’s why they’re wrong.

The realities of the business cycle

Throughout modern history, macroeconomists have observed cyclical behavior among key indicators of economic health. In simple terms, what goes up must come down. In the last three decades, the world (developed markets in particular) has experienced an unprecedented period of economic growth, interrupted only briefly by mild recessions.

What this means is that we went up, really high. In 2007, when we reached the peak and began the descent, government responded by pumping massive amounts of fiscal and monetary stimulus. Rather than let the business cycle run its course, government has interrupted it.

The root of the problem

So what if we interrupted the business cycle? Isn’t that what Keynes is all about? Shouldn’t we be smoothing out consumption patterns? No, not really. Manipulating the business cycle is what got us here in the first place. Instead of weathering recessions in due course, government has “helped” the economy by increasing expenditures through borrowing and encouraging consumers to borrow.

This approach fundamentally ignores the roots of economic decline — the loss of competitiveness. Typically, economic growth slows because we become fat and happy and someone hungrier (China?) beats us at our own game. Instead of absorbing the pain, forcing economic actors to find new competitive activities, and adjusting to reality, politicians prefer to give voters tax breaks and handouts. And so a society stays fat and happy, consuming more and more foreign goods, while its own lack of competitiveness becomes ingrained.

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As a result of these policies, we have not had a deep recession in some 80 years, but the US debt stands at around 100% of GDP. In theory, this should not have happened. The premise behind Keynes’ theory is that once the business cycle has been smoothed and an economy begins growing again replica breitling Aeromarine , government will be able to reduce expenditures and lower the national debt.

Unfortunately, this premise ignores the political reality of fiscal imprudence — once you start, you can’t stop. Voters become accustomed to benefits, developing a sense of entitlement. Moreover, if a country is growing, it is difficult to make the case for fiscal cuts replica breitling bentley 6.75, as tax revenues are likely increasing too. However, when the economy turns for the worst and tax revenues dry up, it’s back to borrowing. And so the “smoother” cycle leads to more and more debt.

Fortunately, the political opportunity has never been more conducive for fiscal consolidation. The public has fundamentally lost confidence in the economy. From the volatile swings in the market, to cash-hoarding corporations, the economy will remain sick until it becomes competitive again. This is the time to convince voters to bite the bullet and figure out what the country is good at doing. The only question is — will politicians rise to the challenge?

November 7, 2011
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