AUSTERITY OR STIMULUS: THE RECENT EVIDENCE

The 2009 Obama stimulus package had a positive effect on our economy, although  there is no telling exactly  how much.  Obama's economists argued that Congress needed to enact it in order to prevent the unemployment rate from soaring above 8%.  Of course, after enactment the rate actually rose above 10%, at its peak.  We just do not know what the rate would have been in the absence of stimulus.  At this point, the stimulus package has run its course and we are left with its $800 billion cost added to our national debt.  And one can argue that an economic recovery already was in the cards in 2009, stimulus package or not, since the recession officially ended in June, 2009, just four months after passage of the stimlus package and well before much of the stimulus money had been spent.  While we can presume that the stimulus muted our economic decline, we must now ask the follow-up question:  How much better off are we today, compared to the counterfactual?  Nobody knows the answer.
 

One reason that I supported Obama's stimulus package was that the country was in a panic and we needed something positive to believe in.  The stimulus package stemmed the panic and raised the economy's animal spirits, somewhat.   In addition to actually saving some jobs (especially through direct aid to the states),  it helped the economy because the public  believed it would.  The placebo effect.   But will it work the next time?  The public seems to think that we are still in recession and that our government's efforts have failed to turn around the economy.  I recall hearing of a poll that found that more people believe that Elvis is alive than believe that deficit spending boosted our economy.  So, next time we have a financial crisis, or even a recession, there likely will be little support for Keynesian stimulus.  And, lacking widespread faith that stimulus actually works, its enactment during future recessions may have little positive effect on animal spirits in our economy.
  
 Regarding Europe, austerity (raising taxes while cutting public spending) seems to be contributing to an economic slowdown.   But, it is hard to separate out the effect of austerity alone, since it has been accompanied by a dimunition and, possibly, reversal of capital flows as countries are unable to borrow as much from outside their borders as previously.  Loan money is no longer flowing into Ireland and Spain to finance their real estate bubbles.  Likewise, capital flows into Greece are diminishing as the government curtails its spending and indivduals and businesses become motivated to send their capital beyond its borders.  So, Greece's decline is unavoidable, but it is hard to say how much is due to tax increases and government cuts, as opposed to the severe tightening of its capital infusions.   The German economy, too,  is slowing, even with no sudden changes in fiscal policy, tied as it is to the Eurozone.
 

     The best test of the impact of austerity lies in a comparison of the US with the UK.  Both countries control their own currency, both dealt with their credit contractions, but the UK switched to austerity after its last election, while the US has put off tax increases and meaningful spending cuts until at least 2013.  So far, growth in the US is marginally higher and is starting to accelerate, while the economy in the UK remains moribund.  Austerity or stimulus?  So far, the US appears to be on the preferred course.  Let's see what 2012 brings.  The jury is still out.