In her hearing before the Senate today, Federal Reserve Board nominee Lael Brainard reportedly said that “expansionary austerity is a contradiction and does not work.” This one-dimensional view of a complex set of policies ignores extensive academic research and lacks the nuance we expect from those who serve on the Board of Governors.
In a Heritage Foundation working paper released last October, Alberto Alesina and Veronique de Rugy, economists at Harvard University and the Mercatus Center, respectively, discussed the nuances of budget-cutting austerity:
While there is little debate that sound fiscal balance and restraints in the burden of spending have a positive impact on GDP [gross domestic product] in the long run, the question of whether, in the short term, budget cuts shrink or grow GDP is far from being settled.…
There is a lot that economists disagree about when it comes to fiscal policy. However, a consensus seems to have emerged recently that spending-based fiscal adjustments are not only more likely to reduce the debt-to-GDP ratio than tax-based ones but also less likely to trigger a recession.
In over two decades of work, starting with Giavazzi and Pagano (1990), academic economists have measured, modeled, and debated the conditions under which austerity has been and can be neutral or even positive for short- and medium-run growth. As outlined by Alesina and de Rugy, the research consensus has arrived at a few key points.
First, the research finds overwhelmingly that spending cuts are less harmful than tax increases. In many cases, both lead to lower short-term growth, but the effects of taxes are harsher and longer lasting. Recent experience confirms that the European countries that raised taxes suffered more.
Second, the research has identified many particular cases in which “expansionary austerity” has occurred. Most, but not all, of those cases occurred in small countries, occurred when global growth was healthy, and involved flexible exchange rates. And most cases occurred where government spending was on an unsustainable trajectory, as it is now in the United States.
Brainard could have accurately said that expansionary austerity was unique or unlikely to occur during a global downturn. But she could have also noted that we know a great deal about how best to execute budget cuts when they are necessary. Most importantly, the mild “austerity” that the U.S. government enacted in 2013 was decisively weighted toward higher taxes, which cost the U.S. jobs and growth.