Several of my colleagues on the Harvard faculty have recently been casualties in the cross-fire between fiscal austerians and stimulators.   Economists Carmen Reinhart and Ken Rogoff have received an unbelievable amount of press attention, ever since they were discovered by three researchers at the University of Massachusetts to have made a spreadsheet error in the first of two papers that examined the statistical relationship between debt and growth.   They quickly conceded their mistake.

Then historian Niall Ferguson, also of Harvard, received much flack when — asked to comment on Keynes’ famous phrase  ”In the long run we are all dead” — he “suggested that Keynes was perhaps indifferent to the long run because he had no children, and that he had no children because he was gay.”  

There is more to be said about each of the two cases.  (i) Reinhart and Rogoff’s 2010 estimates had already been superseded by a subsequent 2012 paper of theirs written along with Carmen’s husband, Vincent, which used a more extensive data set where the error does not appear.  (ii) The debt-growth causality is debated.  (iii) “Some of Ferguson’s best friends are gay.”   (iv) Keynes was actually bi-sexual.  (v) He tried to have children.  And so forth.  Most of this has already been said many times by now.  Apparently people are even more fascinated by Harvard than they are about macroeconomic theory.

But what does it all have to do with the debate between austerians and stimulators?   Not much.  But the battle lines of the austerians have been wavering lately under the continuing onslaught of facts (most notably the recessions in Europe and Japan’s recent conversion to stimulus), and the stimulators find the missteps of Reinhart-Rogoff and Ferguson to be convenient stones to throw into the attack as well.   But they are barking up the wrong tree.  Sorry;  they are throwing the wrong stones.

The Reinhart-Rogoff controversy is not in fact relevant to the question whether governments should expand or contract at a given point in time.  The basic finding in their papers continues to hold up, that subsequent growth tends to be lower among countries with debt/GDP ratios above 90% than below 90%; but neither that finding nor their policy advice was designed so as to support the proposition that a recession is a good time to undertake fiscal contraction. 

The Ferguson controversy is even less relevant, because the phrase “in the long run we are all dead” was neither about fiscal policy when Keynes wrote it nor an argument against deferred gratification.   Nor was Keynes in favor of uninhibited fiscal stimulus regardless of economic conditions;  he argued, rather, “the boom, not the slump, is the right time for austerity at the Treasury.”     Fix the hole in the roof when the sun is shining, not when it is raining.

Neither of the controversies bears on the policy proposition that is important at the moment, which is the Keynesian claim that under conditions of high unemployment, low inflation, and low interest rates (the conditions that hold in rich countries today, as in the 1930s), fiscal expansion is expansionary and fiscal contraction is contractionary.

Some research by yet another highly valued colleague at Harvard does bear much more directly on this important proposition.   Alberto Alesina has not been receiving his “fair share of abuse.”  His influential papers with Roberto Perotti  (1995, 1997) and Silvia Ardagna (1998, 2010) found that cutting government spending is not contractionary and that it may even be expansionary.  

It is true that sometimes a country may have no alternative to fiscal “consolidation,” if its creditors insist on it, as has been the case with Greece and some other euro members.  But that does not mean austerity is expansionary, especially if the currency cannot depreciate to stimulate exports.

As with Reinhart and Rogoff, the Alesina papers themselves are much more measured in their conclusions than one would think from the claims of some conservative politicians that academic research finds fiscal austerity to be expansionary in general.  Nevertheless, the conclusions are clear:  “Even major successful adjustments do not seem to have recessionary consequences, on average” (1997).  And “several fiscal adjustments have been associated with expansions even in the short run” (1998).   And “spending cuts are much more effective than tax increases in stabilizing the debt and avoiding economic downturns. In fact, we uncover several episodes in which spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions” (2010, p.3).   Most recently, a May 2013 paper with Carlo Favero and Francesco Giavazzi finds “that spending-based adjustments have been associated, on average, with mild and short-lived recessions, in many cases with no recession.”  

Alesina’s recent policy advice is that the US should cut spending “right away.”  By contrast, the advice of Reinhart and Rogoff seems to favor postponing fiscal adjustment (trim entitlements in the future, but increase infrastructure spending today) and considering financial repression.  In more far-gone cases like Greece, they lean toward restructuring the debt.   If the thunderstorm is too severe and the roof is too far-gone to be fixed, it may be necessary to rebuild from scratch.

A new attack on Professor Alesina’s econometric findings comes from an unlikely source:   Perotti, the co-author of the first two of the five articles, has now recanted (2013a, b).    He points out some problems with the methodology (including the papers that Alesina wrote with Ardagna).  Under the dating scheme, the same year can count as a consolidation year, a pre-consolidation year, and a post-consolidation year.   It turns out that some of what have been treated as large spending-based consolidations, though announced by the governments, were in fact never implemented.  Currency devaluation, reduced labor costs, and export stimulus played an important part in any instances of growth, for example, the touted stabilizations of Denmark and Ireland in the 1980s.  His conclusions:  “the notion of ‘expansionary fiscal austerity’ in the short run is probably an illusion: a trade-off does seem to exist between fiscal austerity and short-run growth” and so “the fiscal consolidations implemented by several European countries could well aggravate the recession” (2013b, p.10).   To me, this is a more powerful indictment of the reasoning behind recent attempts at fiscal discipline during recession than is a spreadsheet error or a too-flippant line about Keynes’ sexuality.

References
    Alberto Alesina, and Silvia Ardagna, 1998, “Tales of Fiscal Adjustment,” Economic Policy Vol.13, no, 27, October, 487-545.
     Alberto Alesina, and Silvia Ardagna, 2010,  ”Large Changes in Fiscal Policy: Taxes versus Spending,” in Tax Policy and the Economy, Volume 24 (University of Chicago Press).
     Alberto Alesina, Carlo Favero and Francesco Giavazzi, 2013, “The Output Effect of Fiscal Consolidations,” IGIER, May.
     Alberto Alesina and Roberto Perotti. 1995, “Fiscal Expansions and Adjustments in OECD Countries,” Economic Policy, October.  NBER WP 5214.
   Alberto Alesina and Roberto Perotti, 1997, “Fiscal Adjustments In OECD Countries: Composition and Macroeconomic Effects,”  International Monetary Fund Staff Papers, vol.44, no.2, June, 210-248.
     Francesco Giavazzi and Marco Pagano, 1990, “Can Severe Fiscal Contractions be Expansionary?” NBER Macroeconomics Annual 1990, Vol.5, Olivier Blanchard and Stanley Fischer, editors (MIT Press) p. 75 - 122.
    Thomas Herndon, Michael Ash, and Robert Pollin, 2013, “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Political Economy Research Institute WP Series 322,University of Massachusetts Amherst, April.
     Roberto Perotti, 2013a,”The ‘Austerity Myth’: Gains Without Pain?” A. Alesina and F. Giavazzi, eds.: Fiscal Policy After the Financial Crisis (University of Chicago Press). BIS WP 362.  NBER WP no 17571.
     Roberto Perotti, 2013b, “The Sovereign Debt Crisis in Europe: Lessons from the Past, Questions for the Future,” Academic Consultants Meeting , Federal Reserve Board , Washington DC , May 6 , 2013.  Bocconi University.
     Carmen Reinhart and Ken Rogoff, 2010, “Growth in a Time of Debt,” AER, 100, May, 573-578.
     Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff, 2012, “Public Debt Overhangs: Advanced-Economy Episodes Since 1800,” Journal of Economic Perspectives, Vol.26, No.3-Summer, 69-86.

 [Comments can be posted at On Deck of Project Syndicate or on the site of the shortened op-ed version.]

       The world is in the grip of a debate between fiscal austerity and fiscal stimulus.  Opponents of austerity worry about contractionary effects on the economy.  Opponents of stimulus worry about indebtedness and moral hazard.

Is austerity good or bad?   It is as foolish to debate this proposition as it would be to debate whether it is better for a driver to turn left or right.   It depends where the car is on the road. Sometimes left is appropriate, sometimes right.  When an economy is in a boom, the government should run a surplus; other times, when in recession, it should run a deficit.    

True, it is hard for politicians to get the timing of countercyclical fiscal policy exactly right.  This is the reason, more than any other, why Keynesian policy lost its luster.  “Fine-tuning” it was called.  Sometimes the fiscal stimulus would kick in after the recession was already over.   

But this is no reason to follow a pro-cyclical fiscal policy.  A procyclical fiscal policy piles on the spending and tax cuts on top of booms, but reduces spending and raises taxes in response to downturns.  Budgetary profligacy during expansion; austerity in recessions.  Procyclical fiscal policy is destabilizing, because it worsens the dangers of overheating, inflation, and asset bubbles during the booms and exacerbates the losses in output and employment during the recessions.  In other words, a procyclical fiscal policy magnifies the severity of the business cycle.

Yet many politicians in the United States, the United Kingdom, and the eurozone seem to live by procyclicality. They argue against fiscal discipline when the economy is strong, only to become deficit hawks when the economy is weak.  Exactly backwards.

            Consider the positions taken over the last three decades by some American politicians. 

First cycle:    During a recessionary period, President Ronald Reagan in his 1980 campaign and in his 1981 Inaugural Address urged immediate action to reduce the national debt “beginning today.”  (Recession: austerity.)    But in 1988, as the economy approached the peak of the business cycle, candidate George H.W. Bush was unconcerned about budget deficits, even though the national debt was rapidly approaching three times the level it had been when Reagan had given his speeches.   “Read my lips, no new taxes,” Bush famously said.  (Boom: profligacy.)

Second cycle:  Predictably, the first President Bush and the Congress finally summoned the political will to raise taxes and rein in spending growth at precisely the wrong moment, that is, just as the US was entering another recession in 1990.   (Recession: austerity.)  Although the timing of the legislation was poor, the action was courageous.    The Pay as You Go Rule and other reforms switched government finances back onto a path that eventually was to eliminate the deficits by the end of the decade.   

But three years later — and even though the most robust recovery in American history had begun — every Republican congressman voted against Clinton’s 1993 legislation to continue Bush’s spending caps, PAYGO, and tax increases.  Nor did they change their minds in response to the subsequent success of the policy.   Even after seven years of strong growth, with unemployment at the peak of the business cycle dipping below 4% for the first time since the 1960s, George W. Bush based his 2000 campaign on a platform of large long-term tax cuts. (Boom: profligacy.)

Third cycle:  Even after the Bush fiscal expansion had turned the inherited record budget surpluses into record deficits, the Administration went for a 2^nd round of tax cuts in 2003, and continued a rate of growth of spending that was triple the rate under Clinton (both national security and domestic spending).  Vice President Richard Cheney said “Reagan proved that deficits don’t matter.”   These policies were maintained for five more years, as another $ four trillion was added to the national debt.  (Boom: profligacy.)  

Predictably, when the worst recession since the Great Depression hit in 2007-09, politicians felt constrained from an adequate fiscal response due to the big deficits and debts the government had already been running. Republicans suddenly re-discovered the evil of budget deficits and decided that retrenchment was urgent.  They opposed Obama’s initial fiscal stimulus in February 2009, even though GDP growth and employment were much worse than they had been when Reagan and Bush had launched their tax cuts and spending increases.  (Recession: austerity.)   Subsequently, with a new majority in the House, they succeeded in blocking further efforts by Obama when the stimulus ran out in 2011.  The government spending cutbacks of the last two years are the most important reason, in my view, why the economic recovery which began in June 2009 subsequently stalled in 2011.

Three cycles.   Three generations of politicians who favored expansionary fiscal policies during a boom and then decided after a recession had hit that budget deficits were bad after all.  (See the graph below.)

This is not to say that the procyclicalist politicians have always succeeded in getting their policies adopted.   Clinton had a strong enough congressional majority in August 1993 that he was able to pass his budget balancing legislation (Omnibus Budget Reconciliation Act) — even though every Republican in Congress voted “no” at a time when the economy was expanding.  Similarly, Obama had a strong enough majority in January 2009 that he was able to pass some initial fiscal stimulus (the American Recovery and Reinvestment Act), without a single Republican vote, at a time when the economy was in freefall.  But too often the countercyclicalists are overpowered by the procyclicalists.

            Trying to turn left or right at precisely the wrong points in the road is a worse record than one would get by switching policies randomly.  To explain this perverse pattern, let us switch metaphors in mid-stream.   It is the old problem of needing to fix the hole in the roof when the sun is shining, rather than waiting for a storm to realize that it is necessary.  When the economy is booming, there is no political support for painful spending cuts or tax increases.  After all, everything seems fine; why make a change?   Then when the deluge comes, sinners suddenly see the evils of their ways and proclaim the necessity of reforming.  Of course it is very difficult to fix the roof in the middle of a thunderstorm.

Procyclical Politicians:  Support for fiscal contraction (down-arrows) and fiscal expansion (up-arrows) 

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