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Home Publications Blogs CEPR Blog Austerity and the Employment Rate

Austerity and the Employment Rate

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Written by Ben Wolcott   
Monday, 09 June 2014 16:07

In 2010, after an initial round of coordinated stimulus from both wealthy and developing countries, deficit hawks around the world regrouped. Pointing to growing deficits and debt, they demanded that countries reverse course and begin moving toward balanced budgets. The deficit hawks argued that deficit reduction could be accomplished without impairing growth because of the effect it would have in boosting confidence among businesses and consumers.

Many economists argued against this drive towards austerity at the time. They noted and rigorously explained the fallacious logic in the idea that deficit reduction could be expansionary. They also pointed out how fiscal policy had already saved the economy from a second depression and that more stimulus would likely be necessary. However, now we have more than three years of data, so we no longer have to speculate. A simple picture can be worth a thousand words (or in this case, billions).

wolcott-2014-06-09

The figure plots the change in the structural balance since 2010 against the change in the employment rate (the percentage of the workforce that is employed) over the same time period. The structural balance is an accounting tool that is designed to measure changes in fiscal policy. For this reason, it tries to pull out the effect of cyclical fluctuations. This means that if the structural deficit gets smaller it is because the government has changed its policy to move toward smaller deficits with budget cuts and/or tax increases. The more negative the change in the structural deficit, the larger the mix of spending cuts and tax increases. Plotting the change in the structural balance against the change in the employment rate gives us a picture of how countries that abandoned fiscal policy strategies quickly have fared since 2010.

In order to understand this picture, it is important to contextualize the position of each country with an understanding of their economic situation in 2010 and the various predictions economists and policy makers offered after the Great Recession. First, many countries were running relatively large structural balance deficits and had high unemployment in 2010. Therefore, if the pain caucus predictions were correct, we would expect to see a strong positive correlation between changes in the structural balance and employment rate. In this worldview, as countries like Greece and Spain cut their budgets in order to qualify for international support, increased confidence in financial markets would return them to full employment quickly. 

Clearly, the data show the opposite trend. This image very crisply suggests what Keynesians have been arguing in more nuanced ways for four years, namely that many countries cut fiscal spending too soon, prolonging the negative impacts of the Great Recession for workers. In this respect it is perhaps worth highlighting the example of Japan. No country has a debt level anywhere near Japan’s which is now approaching 250 percent of GDP. Nonetheless the country’s new Prime Minister, Shinzo Abe, pushed through a vigorous stimulus program that began to take effect early in 2013. The economy responded as would be predicted by textbook Keynesian economics, growth accelerated, the inflation rate increased modestly, and the employment to population ratio rose by 1.7 percentage points, the equivalent of 4 million new jobs in the United States.

It is tragic to realize that too many economists and policy makers have not learned what Keynes explained in The General Theory of Employment, Interest and Money in 1936. There is no good reason that so many countries employment rates have barely budged or decreased since 2010. It seems Robert Lucas was wrong when he said, “I guess we are all Keynesians in the foxhole.”

Comments (9)Add Comment
Deficit hawk dummies.
written by Ralph Musgrave, June 09, 2014 10:58

The basic reason deficit hawks object to a rise in the national debt is that the phrase “national debt” includes the word “debt”, and that word has negative emotional overtones. If we scrubbed the phrase “national debt” and replaced it with “national savings” (and government debt actually is a form of private saving) then the deficit hawk dummies, including Kenneth Rogoff, wouldn’t be bothered by the rise in the national debt.

In fact if the national debt was renamed “the national giraffe”, deficit hawks would all become convinced that the national debt was an animal with a long neck.

Japan is the beacon for Keynesian economics?
written by Bruce Krasting, June 10, 2014 5:56
Wow! talk about going out on a limb! The author points to Japan as an example of Keynesian success??

Devalue the currency, pump up debt to ridiculous levels, Zero interest rates and zero bond yields, endless buying of debts by the Central Bank and public deficits that can't be sustained.

The author is going to have some explaining to do when, in the not distant future, the insane experiment with Keynes in Japan suffers a miserable failure.

Check back in a year on that "Japan Success Story".
Let's do a Bruce Krasting "check back".
written by Ralph Musgrave, June 10, 2014 7:38

Bruce Krasting,

There’s no need to “check back” in a year’s time to see how Japan is doing. What you call their “insane” debt level (about 200% of GDP) was the level that pertained in the UK and US just after WWII. So let’s do a “check back” shall we?

Economic growth and employment levels were just fine in the 1950s and early 60s in both the US and UK.

QED.
The correlation is Euro Area driven.
written by Mark A. Sadowski, June 10, 2014 4:36
Remove the 8 Euro Area members, and the one country pegged to the Euro (Denmark), and the correlation vanishes. No one doubts that fiscal policy has significant effects when one controls for monetary policy (the Euro Area members all have the same monetary policy). But monetary policy can offset fiscal policy, otherwise why do we see so many of these types of scatterplots dominated by Euro Area members?
Abenomics is Mostly Monetary Stimulus, not Fiscal
written by Mark A. Sadowski, June 10, 2014 5:01
"In this respect it is perhaps worth highlighting the example of Japan. No country has a debt level anywhere near Japan’s which is now approaching 250 percent of GDP. Nonetheless the country’s new Prime Minister, Shinzo Abe, pushed through a vigorous stimulus program that began to take effect early in 2013. The economy responded as would be predicted by textbook Keynesian economics, growth accelerated, the inflation rate increased modestly, and the employment to population ratio rose by 1.7 percentage points, the equivalent of 4 million new jobs in the United States."

According to the IMF Fiscal Monitor the Japanese cyclically adjusted primary balance (CAPB) decreased by only 0.3% of potential GDP in calendar year 2013 (bottom half of Table 2):

http://www.imf.org/external/pubs/ft/fm/2014/01/pdf/fm1401.pdf

The fiscal stimulus part of Abenomics is tiny. By far rhe most important part of Abenomics has been its massive QE.
Have you heard of outliers driving the data?
written by Chance Rose, June 11, 2014 9:31
This is a worthless analysis. I recreated the graph as best I could from what you have here. With Greece in, your regression is barely significant, and the R^2 value is only ~50%. Take Greece out, and the regression becomes statistically insignificant and the R^2 falls into single digits.

This is purely ideologically driven (and I'm on your side). Charts like this give people ammunition to say that statistics are just another way to lie, because that is what you are doing if you say this chart has meaning.
Responding to Chance Rose: The Results Are Statistically and Economically Significant
written by Benjamin Wolcott, June 11, 2014 2:01
In my blog post, I explicitly said that this was a simple figure that validated more rigorous methods. Bivariate regressions are not a good way to rigorously examine the impacts of austerity. That being said, using the data set I compiled, the t-stat when Greece is included is -5.10 (p-value of 0.000) and -1.93 (p-value of .077) when Greece is excluded. While I don’t think that the R^2’s tell us much without comparisons within a larger literature, it is .667 in the first case and .238 in the second. Clearly Greece drives the extreme significance of the first results, but the second is still significant at the 10% level, which is a reasonable level considering the small sample size. It is also reasonable to conclude that this is economically significant because Greece is only an outlier in the sense that its recent history is an extreme example of what happened in many other countries. I wouldn’t conclude economic significance if Greece drove the entire result, but it doesn’t, it just plays a large role. If you would like a copy of my excel file, please send me an email at wolcott@cepr.net.
Outliars? Bah, humbug
written by Larry Signor, June 12, 2014 8:47
This a great data set and graph which clearly exhibits the effects of untimely austerity. Greece merely changes the slope of the regression, not the overall inclination of the slope or conclusions of the graph. Nice work, Ben. [Excluding Greece could potentially steepen the slope, reinforcing your analysis.]
What Correlation
written by Nate, June 18, 2014 9:08
That is a very loose correlation. What's the R^2 on that, like .5? For those that don't know, R^2 measures how close the data points match the trend line superimposed on the graph. The values go from 0 to 1, 1 meaning the data matches the trend perfectly. Values over .9 are considered strong correlations. This graph doesn't look anywhere near that. The author is stretching the data to argue a point. Despicable.

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