What happened to austerity politics?
Or, why is 2022 not playing out like 2010?
The new British Prime Minister Liz Truss and her Chancellor of the Exchequer Kwasi Kwarteng faced some rough sledding in the financial markets after they proposed their mini-budget late last week. The hard-working staff here at Drezner’s World will tackle the implications of those policy choices next week. For now what seems really odd is that the macroeconomics of the Truss/Kwarteng plan of massive tax cuts and increased fuel subsidies seem spectacularly ill-advised for an economy facing high levels of inflation. A case could be made that this is a rare moment when fiscal austerity would the appropriate response.
That is not what the Truss government is doing. Indeed, they have upended the Conservative Party’s traditional predilection for austerity at precisely the moment when it might have been the right thing to do. Which leads to a question Joe Weisenthal tweeted out that has stuck in my craw for a while now and seems worth answering:
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It’s a good question! Unless you are an Austrian economics enthusiast or a modern monetary theory devotee, basic macroeconomics says that fiscal austerity is the appropriate response when an economy is overheating and fiscal expansion is the best policy when an economy has plenty of excess capacity. A quick glance at the unemployment rate shows that the British economy had much more slack in 2010 than it has in 2022. Nonetheless, austerity was the watchword back then and it sure ain’t that now. Why?
My answer to this question is rooted in the same logic that I used when I wrote The System Worked. What was striking about the 2008 financial crisis was that it initially failed to dislodge the dominant set of economic theories that policymakers followed. Call it “neoliberalism” or “the Washington Consensus” or whatever populist epithet you want to use, but it was an intellectually consistent set of economic policies that consisted of:
Removal of price controls and quantitative restrictions
A commitment to keeping inflation low
The important thing to realize about these set of ideas is that they were interlocking. Even if the circumstances justified deviating from policy orthodoxy in one area, it would look disjunctive. And as Ron Krebs and others have pointed out, disjunctive ideas usually do not last long.
This brings us to the differences between 2010 and 2022. In the response to the 2008 financial crisis, governments largely adhered to these principles. In general, tariffs stayed pretty low, capital accounts stayed open, and there were minimal microeconomic interventions.
The temporary exception was a brief return to Keynesianism between late 2008 and early 2010, but it rubbed a lot of folks the wrong way. It was disjunctive with broader neoliberal tenets and also inconsistent with the conviction of macroeconomists that fiscal policy was not the right way to manage business cycle fluctuations. Hence, when Alesina and Ardagna and then Reinhart and Rogoff made the case for austerity, their policymaking audience was primed to be receptive.
Fast forward to 2022, and hoo boy has the Washington Consensus has been beaten and beaten good. First the surge in populist nationalism, then the return of great power rivalry, then the pandemic, and then the stresses on the global supply chain have all brought faith in free markets to a new low. Free trade is no longer the watchword for policymakers in Washington or Beijing. The great powers have become huge fans of industrial policy, price caps, and plenty of other microeconomic interventions into the marketplace.
In this world, more aggressive priming the pump seems to be more intellectually acceptable. The fact that such actions worked really, really well in 2020, preventing the pandemic from creating another Great Depression was yet another data point against austerity. So, by the way, was the fact that when austerity was tried in 2010 it worked out horribly.
There is a stronger case to be made for fiscal austerity in the developed world now than in 2010. It does not matter. To the extent that the set of dominant economic ideas out there function as a constraint, the current set of ideas are hostile to the very idea of austerity.
Maybe inflation will change that sentiment, as it did in the 1970s. The ideational structure of the global political economy is not there yet, however.