Garett Jones - Economist at George Mason University. Follow him on Twitter: @GarettJones
"Stimulus now, austerity later." Sounds like good economic policy, whatever your political leanings. If you're on the right, you want tax cuts now, if you're on the left, you want government spending to get the economy moving.
If the promises of politicians were credible, that just
might be a practical policy. But it's
not. In practice, the path to austerity
involves some tough love.
I'll abuse the term "austerity" here a bit to talk about the great Federal Reserve Chairman Paul Volcker, appointed by President Carter. When Volcker battled 10% inflation in the early 80's, he didn't say, "I'll bring inflation down slowly over a half a decade." Instead, he raised short-term interest rates by 10% (!), which caused a massive recession and 10% unemployment. That got banks to slow down their lending, it got workers to take pay cuts, and it got businesses to slow down their price hikes.
That's how we got the excellent 3% inflation rate of the rest of the Reagan years. It took a major, upfront sacrifice: And business leaders, unions, and banks alike got the message: The age of high inflation was over. For the first time in years, the Federal Reserve had regained its credibility as an inflation fighter.
Why couldn't Volcker have eased into an inflation fight? Because nobody would have believed him, and credibility is the name of the game when you're fighting inflation. And for good reason: in the 70's, Fed officials always said they were going to fight inflation right after they got back from lunch, as Hetzel showed in his excellent history of Fed policy. Since politicians and bureaucrats can rarely sign real contracts, the best way to prove you'll do something later is to do it now.
Isn't there any alternative? Yes: The alternative is to have a great reputation as an inflation fighter -- or in the fiscal realm, as a nation that eventually gets its fiscal house in order. The U.S. and a few other countries do (did?) have such reputations, purchased in the past at a high price -- purchased at the price of past tough love. Once your politicians have built a good reputation, you can do quantitative easing without setting off inflation, you can run massive deficits without scaring bondholders. But reputations get spent. It's hard to say how quickly, but you can only come home late from work so often before your spouse starts wondering....
For other nations without such reputations: No such luck. Pain now is the way to show you'll endure pain later. Would that we had a fix for that; but the painful or humiliating initiation rituals of many social groups suggest that the problem of commitment is a persistently human one. We screen out the free-riders, the loafers, the big talkers, by making them pay the tax up front. No need to name particular countries here.
This is why pleas for "Stimulus now, austerity later" in the U.S. and Europe have the ring of chalkboard economics: Looks great in (someone's) theory, but out in the real world the market and the citizens see right through it. The biggest economic problems are political: And the biggest political problem is commitment.
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