Austerity

How does the policy of "austerity" fit in with anything that I've mentioned below? What is it, who's in favor of it, what nations are pursuing it, and why?  First, a definition.  The policy of austerity simply means lower deficits via either higher taxes, lower government spending, or some combination of both.

   

                                                            Source:  Google Images

Macroeconomic Goals

There are three main macroeconomic goals in our society:

1. Full employment
2. Stable prices
3. Economic Growth

First, full employment means that the nation's unemployment rate is no higher than about 5-7%, what's often referred to as the "natural rate" of unemployment or the "full employment rate" of unemployment.  Second, stable prices mean that the inflation rate should be relatively low and non-erratic, but a number as to exactly how low isn't typically mentioned.  Finally, economic growth should at least exceed the average growth rate over the last century, which has been about 3% per year. Essentially, all three goals leave some room for variation, and that's a good thing. Remember the topic about "confidence" below (see 6/17/13 entry).

Do the goals above seem like reasonable goals for a nation?  Should there be more goals, such as lower deficits and debt?  Are any of the above goals "mutually exclusive", meaning you can't achieve two or more goals at the same time (example -- lower deficits along with economic growth)?

Economic growth

So, how does a nation restore confidence in order to create economic growth?  The photo below is from 1929, but there are plenty of modern versions of this on street corners today.

                                                                   Source:  Google Images

Erosion of Confidence

Let's apply this type of thinking (overall confidence, or rather lack of) to the Great Depression and also to our most recent downturn (i.e., recession) of 2007-2008.

The Great Depression wasn't caused by one single event; however, the 1929 stock market crash certainly started off the downward spiral.  Though other factors contributed to the GDP decline, that one event (the stock market crash) began the overall erosion of confidence that individuals had in the U.S. economic system.

Compare that confidence erosion during the fall of 1929 with what happened to our recent economy in 2007-2008.  Our economic downturn was also given a name --- the "worst recession since the Great Depression"; thus, contributing to an even greater confidence deflator.

Belief = Performance!

The economy's overall performance can be compared to an individual, and their overall performance.  It's well-known that the total "output" of an individual is positively correlated with the confidence they possess.  What a person believes deep down about their ability and their chances of success will ultimately determine what they can and will become.

                                          Belief = Performance!

The economy is driven by a similar set of circumstances.  If the general belief is that the economy is doing well, and people (at least, collectively) have enough confidence in it, then, just like a self-fulfilling prophecy, the economy will end up doing well.

What do YOU believe about today's economy?  Is it doing well or not, and why?

Recession and spending

Someone recently said to me, "You can't spend your way out of a recession.".  I thought this line was interesting and curious, and maybe you do too.  If you eliminate spending as a cure for a depressed economy, what are some reasonable alternatives?

Liquidity Trap!

If you've been reading Dr. Paul Krugman (New York Times) since the election, you know that he's been discussing our current economy along with the concept of a liquidity trap.  In his blog article (http://krugman.blogs.nytimes.com) from 12/1/12, he makes the statement that, " ... the whole case for fiscal stimulus and against austerity rests on the proposition that with interest rates up against the zero lower bound, the central bank can neither achieve full employment on its own nor offset the contractionary effect of spending cuts or tax hikes.".

It's always so great when economic theory matches real world events! For more information about liquidity traps, Keynesian theory, monetary policy, or the IS-LM curve, I would suggest googling the concepts, or better yet, finding a good economics text.