Simon Wren-Lewis on expansionary austerity By Scott Sumner

Everyone from market monetarists to Jeffrey Sachs have recently been pointing out that the Keynesian predictions about austerity have been shown to be incorrect. Now Simon Wren-Lewis has a post that tries to salvage the Keynesian model. Unfortunately he fails to do so. Here he tries to defend Paul Krugman:

Of course the proper way to tackle this is as Paul Krugman does. As he says other stuff happens (like a large fall in the US savings ratio in 2013), so you need to go beyond a single country and look at lots of data.

First of all, it was Paul Krugman who suggested that 2013 would be a test of the market monetarist claim that monetary stimulus offsets the effects of fiscal austerity, not me. After the test strongly supported the claim that fiscal austerity does not slow growth, he changed his mind. Suddenly it was not a good test.

But what about the reverse case? Suppose the Cameron government does fiscal austerity in late 2010 and 2011 and growth slows. Correct me if I am wrong, but didn’t Keynesians like Paul Krugman and Simon Wren-Lewis say that the British case refutes claims of expansionary austerity? So how is it that a single data point can be important when it supports your argument, but not when it refutes it?

Yes, it would be useful to do a more systematic study of fiscal austerity, but the Keynesians don’t seem to know how to do so. All I see are cross sectional studies that mix together countries with an independent monetary policy, with those that lack an independent monetary policy (like the eurozone members.) Mark Sadowski did a regression with only those countries having an independent monetary policy, and found the effect went away. No correlation between austerity and growth. This objection to Krugman’s graphs has been made over and over again, but he never responds.

Simon Wren-Lewis also gets the GDP growth data wrong, in a way that makes austerity look worse. He claims that RGDP growth was 2.3% in 2012 and 2.2% in 2013 (the year of austerity in the US.) But that’s annual y-o-y data, and since the austerity began on January 1st 2013, you need Q4 over Q4 data. In fact, RGDP growth in 2012, Q4 over Q4, was only 1.67%, whereas growth in the austerity year of 2013 nearly doubled to 3.13%.

Wren-Lewis says “other stuff happens.” Yes, but the “other stuff” that happened in 2013 is exactly what you might expect with aggressive monetary stimulus, whereas the other stuff that happened when Britain saw a couple years of low RGDP growth, was not at all what the Keynesian model predicts. The British growth slowdown was a productivity story (their job creation is more impressive than the US), and productivity slowdowns suggest supply-side factors (declining North Sea oil output, a structural shift from high compensation City jobs to low compensation service sector jobs, etc.)

Over at TheMoneyIllusion I point out that Krugman’s 2014 experiment turned out just as poorly as his 2013 experiment.

HT: Bob Murphy