Blogging the Zombies: Expansionary Austerity – Life

Another instalment in the new  draft chapter on Expansionary Austerity, which I’m writing for the paperback edition of Zombie Economics. Comments and criticism much appreciated

Despite the advocacy of Keynes, the Treasury View prevailed. When the majority of the Labour government elected in 1929 rejected the austerity policies proposed by Treasury, the government split. The Prime Minister, Ramsay MacDonald and Chancellor of the Exchequer, abandoned Labour and joined the Conservatives in a ‘National Government’, which held office throughout the 1930s.

The effects of austerity were disastrous.  The unemployment rate in Britain. Unemployment rates were above 20 per cent throughout the 1930s, and even higher in the ‘depressed areas’ of the North.

But with the Labour party divided and discredited, and the Liberal Party in terminal decline, there was no alternative. MacDonald was soon pushed aside, along with the remaining pretensions of the National Government to any concern about the poor and unemployed. The Conservatives would remain in office for another decade, before finally being swept aside by a resurgent Labour Party in 1945.

If the effects of austerity were bad in Britain, they were disastrous in Germany and Japan. By 1929, Germany seemed finally on the path to recovery after the destruction wrought by what was then called the Great War of 1914-18, the punitive treaty of Versailles and the hyperinflation of the early 1920s.  The extremists of the Communist and Nazi parties had been marginalized, and a moderately left-of-centre coalition, led by the Social Democratic party, held power.

The Depression hit the government hard, and provoked a demand for austerity policies, most notably a cut in unemployment benefits. The finance minister, Rudolf Hilferding was a leading Marxist theoretician, but in matters of macroeconomic management Marxist orthodoxy coincided with the Treasury view. Hilferding argued that, while crises and depressions would inevitably bring about the downfall of capitalism in due course, in the meantime, there was nothing to do but to follow the dictates of capitalist sound money.

As in Britain, the government split and fell, and was replaced by a conservative government led by Heinrich Bruning. Bruning pushed austerity policies even harder, steadily losing public support and driving the growth of the extreme parties, most notably the Nazis. By the time he fell from office in 1932, Hitler was unstoppable.

Much the same story played out in Japan. As the Depression intensified, the civilian governments imposed austerity measures that produced a sharp deterioriation in living standards. After a period of chaos, with growing political violence and assassinations, the military took over government, using the time-honored policy of international aggression to cement domestic support. The invasion of Manchuria in 1931 was the first in a series leading up to the Pearl Harbor attacks of 1941, and Japan’s entry into World War II.

The policy of austerity did not triumph everywhere. In some countries, including Sweden and New Zealand, social democratic or labour governments came to power in the early years of the Depression, with a commitment to radical reform and a willingness to use the power of the state to promote economic recovery. The Social Democratic idea of the ‘Folkhemmet’ (People’s Home) formed the basis of a consensus that dominated Swedish (and, more generally, Scandinavian) politics for decades, before being eroded by the forces of market liberalism after the crises of the 1970s and 1980s. Similarly, in New Zealand, the Labour government of Michael Joseph Savage transformed the country. Savage’s picture was a staple decoration of working class homes in New Zealand during his lirgetime, and fifty years after his death he remains  the nation’s most admired political leader.

The most important alternative to the politics of austerity, however, was Franklin D Roosevelt’s New Deal. By the time Roosevelt took office in 1933, the Great Depression was nearly four years old, and the banking system was on the verge of collapse. The idea that the economy would return to full employment through market process of adjustment was ad discredited as it had ever been.

 Roosevelt was not a Keynesian. In fact, he came to office promising to restore budget balance. He was, however an instinctive activist who was unwilling to sit by and do nothing when a third of the workforce was unemployed. His National Industrial Recovery Act (NIRA), had two main components. The first, the National Recovery Administration incorporated some positive elements such as union rights, but these were placed in the context of an attempt to overcome deflation through the encouragement of cartels. Fortunately, perhaps, the Supreme Court ruled key parts the NRA unconstitutional in 1935.

The other part of Roosevelt’s program, the Public Works Administration was more in line with the prescriptions of Keynesian fiscal stimulus, as was the Works Progress Administration created in 1935.

The stimulus associated with the New Deal was inadequate to deal with the shock of the Depression, and was intermittent,. Faced with criticism about budget deficits, Roosevelt undertook a major reversal in 1937 which almost precipitated a new Depression.

It was not until the outbreak of World War II in 1939 that fiscal policy was directed to the goal of mobilising all available resources. The resulting upsurge in economic activity, and the contrast with the Depression years, killed the idea of expansionary austerity, seemingly once and for all.

Posted via email from John’s posterous

54 thoughts on “Blogging the Zombies: Expansionary Austerity – Life

  1. You need to read Cole and Ohanian’s many papers on the great depression. Hoover had a very expansionary fiscal policy before Roosevelt too. It didn’t help. You conveniently forget that. Also, what about Valerie Ramey’s recent survey paper on the size of government spending multipliers? She gives a table of results from various researchers. They tend to be quite small.

  2. What about Australia? No mention of the Scullin government? Theodore’s fiduciary issue? The Premier’s Plan?

  3. On Austerity:

    on WJ Savage – what you fail to provide is a simple fact. The time of Savage (which somewhat followed the depression during which everyone with money took their money from the country) NZ was selling all of its produce for very good prices to Great Britain. The country was very rich. The NS pound was worth considerably more than the Aussie. When GB joined the EU all that changed and social welfare services have been generally downhill ever since.


  4. Keynes wrote a letter to Roosevelt where he showed he disapproved of many of his policies.

    In short the cartelisation, increased in real wages et al prevented a ‘Germanic’ recovery.

    The original plan sent to the Premiers which involved a reduction in government expenditure but with a very large devaluation ( obstructed by initially by White) and then following with increases in infrastructure spending was approved by Keynes but was in fact rejected by White although eventually most of it came into being.
    We did see a fall in unemployment here as one might expect however we never go to full employment. We had 11% just prior to WW2 which then fell to around 4% a year after WW2 started.
    NZ was much superior on unemployment.

    the UK is very debatable.

    There clearly was a recovery once Devaluation occurred and interest rates were cut.
    The large debate occurs over whether the structural part of the budget improvement occurred or not.
    Critics believe the structural part of the budget got mixed up with the cyclical parts and so improved as the economy did.

    It is also significant that dwelling investment led the recovery and there was a significant increase in this in the 1931 budget.

    If you compare growth rates of the UK and USA then the UK growth rates were puny.

    The only country to get to full employment was Germany. It did this through strong rises in public expenditure and a reduction in real wages.
    As Ritschl has pointed out this was not a true Keynesian recovery as consumers wre not allowed to spend.

  5. I should add if Hayek could realise his error in supporting a deflationary dpression as a cure for Germany and realise it only enabled Hitler to gain power surely his supporters can do no less.

    That is classical economics great claim to fame. It gave the world Adolph Hitler

  6. As well as Roosevelt having a measure of equivocation regarding the stimulus with the US political system he wouldn’t have had a free hand. I don’t know the detail of the history but would guess that Roosevelt would not have found Congressional support for stimulus easy to get, and I also imagine that anytime the stimulus programs were starting to show results the immediate reaction in Congress would have been “problem solved, so lets cut back this wasteful stimulus expenditure”. Thankfully God provided a second world war which provided a large and enduring stimulus, and also destroyed a lot of capital stock in Europe and Japan which required replacing, thereby providing good times through the ’50s and ’60s. Divine providence I guess. I guess thats why the flowers toil not, or whatever.

  7. Regarding ‘multipliers’, multipliers are certain to be radically different depending on the state of the economy with them likely to be much larger when you need them (that is in recession or depression) than when you don’t need them (a boom). Also, anyone with more than a casual knowledge of econometrics would be unsurprised that people who want to find small multipliers are quite capable of doing so. Regarding econometrics with motivated objectives, John von Neumann provided a great quote about parameters “With four parameters I can fit an elephant, and with five I can make him wiggle his trunk.”

  8. Actually, the von Neumann quote would be great for the Dynamic Stochastic General Equilibrium Modeling chapter as those models tend to be parameter “rich”.

  9. DSGE pink elephants, or is that white, are capable of standing on one leg and there is nothing they can’t wiggle.

  10. This is an interesting post by Thomas Palley: “Deaf to History’s Rhyme: Why President Obama is Failing” And has this from a speech by FDR in 1936:

    “For twelve years this nation was afflicted with hear-nothing, see-nothing, do-nothing government. The nation looked to government but the government looked away. Nine mocking years with the golden calf and three long years with the scourge! Nine crazy years at the ticker and three long years in the breadlines! Nine mad years of mirage and three long years of despair! Powerful influences strive today to restore that kind of government with its doctrine that that government is best which is most indifferent.”

  11. Pr Q said:

    The policy of austerity did not triumph everywhere…The most important alternative to the politics of austerity, however, was Franklin D Roosevelt’s New Deal.

    Ahem…Pr Q seems to be overlooking the world’s most successful macroeconomic politician: Adolf Hitler. I can understand Pr Q’s reluctance to put his political demon on the same pedestal as his economic oracle but the plain facts of history do not necessarily fit a liberal morality play. Anyone writing a hostile critique of austerity economics should give credit where its due to the first leader to implement successful counter-austerity macro-economic policies.

    Omitting the Nazi embrace of Keynsianism is even more of a glaring omission, given that Keynes himself was quick to praise the totalitarian powers for their wilingness and ability to embrace state interventionistm in general and macro-economic policies in particular, at least in their management of the Great Depression. In the German preface to the General Theory Keynes makes the affinity of Keynsian economics and authoritarian government more explicit:

    The theory of aggregated production, which is the point of the following book, nevertheless can be much easier adapted to the conditions of a totalitarian state than the theory of production and distribution of a given production put forth under conditions of free competition and a large degree of laissez-faire…Although I have, after all, worked it out with a view to the conditions prevailing in the Anglo-Saxon countries where a large degree of laissez-faire still prevails, it yet remains applicable in situations where national leadership is more pronounced.

    Moreover the facts of economic history bear out Keynes’ political intuition. Germany was the first great power to recover from the Great Depression, largely through Hitler’s vigorous re-armament plans, plus some ideological nastiness (curbing trade union militancy, pushing women out of the workforce and Jews out of the country)/ This nonetheless helped curb unemployment, amongst Germanic males at least. Wikipedia reports on the Fuhrer’s lengthy stint as the boss of the World’s Greatest Treasurer:

    The economic policies of the Third Reich were in the beginning the brainchildren of Schacht, who assumed office as president of the central bank under Hitler in 1933, and became finance minister in the following year. Schacht was one of the few finance ministers to take advantage of the freedom provided by the end of the gold standard to keep interest rates low and government budget deficits high, with massive public works funded by large budget deficits. The consequence was an extremely rapid decline in unemployment—the most rapid decline in unemployment in any country during the Great Depression. Eventually this Keynesian economic policy was supplemented by the boost to demand provided by rearmament and swelling military spending.

    And just to prove the connection between Keynsian macro-economics and authoritarian government was no fluke we have the recent example of the PRC’s sensible and rational response to the GFC – the biggest fiscal stimulus in history. Wikipedia reports on the revival of Keynsianism in the highest reaches of the Communist Party:

    The 2008–2009 Chinese economic stimulus plan is a RMB¥ 4 trillion (US$ 586 billion) stimulus package announced by the central government of the People’s Republic of China on 9 November 2008 as an attempt to minimize the impact of the global financial crisis on the world’s second largest economy.

    The plan was a smashing success, I predicted as much in FEB 2009 around the time that Pr Q, amongst others, were predicting the imminent collapse of the PRC due to something or other.

    In contrast over the past few years both the EU and US have floundered in various self-created political impasses. (And not just in economics, also ecologic policy – witness the colossal hash being made of carbon trading schemes.)

    Political authoritarianism evidently works well, at least in the short to medium term, to fix up the economic and ecologic messes created by liberals absent of adult supervision. I kind of wish it werent so, but am rapidly growing tired of making excuses for liberals who can’t get things done.

  12. Hope you are not engaging in a genetic fallacy? Adolf certainly did demonstrate that a Keynesian stimulus works and also his regime was enlightened concerning smoking cigarettes and the adverse effects on health. So what? One plus one probably continued to sum to two in Germany during that period as well.

  13. I am pointing out the ideological fallacy of assuming good (Keynsian) economics always goes with good (liberal) politics. Life is not a morality play, sometimes the good guys dont win, sometimes for good to win, bad must be done ie Machiavelli rules.

    The contemporary examples of PRC economic policy and Gillard-ALP political machinations serve well to demonstrate this, rather obvious, point.

  14. And the rapid economic development in the USSR under Stalinism too. In the 1930s and 40s the most successful economies were of the command and control type. “Liberalism” was a 19th century institutional arrangement that struggled to adapt to the machine age. Prof Quiggin mentions that “perhaps fortunately” (why??) the Supreme Court ruled the NRA to be unconstitutional – they did the same with several other New Deal programs prior to 1937. It should then also be mentioned that FDR’s response was a plan to stack the court with extra justices. Although this plan failed, the court became less opposed to the New Deal after the threat had been made, and due to FDR’s extremely long term in office he was eventually able to appoint a progressive majority. The whole episodes represents the adaptation of a 19th century liberal constitution to the demands of 20th century state-capitalism

  15. Since modern austerity policy especially in the european context involves th ECB’s aversion to expansionary monetary policy, this might be a great point to talk about the changes in the gold standard made in 1933

  16. Nazi Germany was a bit more sophisticated than simple command and control, and the USSR was hardly successful. The Soviet approach was incredibly inefficient, particularly, but not only, because they eschewed the price mechanism. However there was significant forced accumulation of capital stock. A government that is willing to kill large numbers of its citizens can also create a lot of capital accumulation by simply taking and by using the labour force as it sees fit. In the Soviet economy the government didn’t need to stimulate demand to create full employment. They simply made everyone work wherever they wanted them to work, and took a lot of what was produced. The Soviet ‘success’ story had little to recommend it.

    Although the Soviets had some limited success in those early years, the success of the same sort of coercive tactics would likely be even more limited in a modern economy which is more vulnerable to subtle and anonymous sabotage and generally requires a high level of cooperation to run smoothly.

  17. @ KB Keynes
    Not that i want to disagree with your analysis of who had best stimulus policies but what it gave the world. The cause that gave Hitler such power which he abused, but FDR and NZ premier didn’t, was idolizing such godlike thinking and achievement(low unemployment) comparing it to idiocy of “expansionary austerity” of the rest of the world.
    As you can see from Dr. JQ post that all who implemented Keynesian policies were idolized during and long after their time except those that abused their fame and power over masses like Hirohito and Hitler. In US Democrats ruled overwhelmingly until LBJ signed Civil Rights Act in ’64.

    @ Jack Strocchi
    I Also do not disagree with your analysis but your emotional name for political authoritarianism, since every government is that and which it uses it to serve the people(when good instead wealthy when bad). How do you call “expansionary austerity”? Banker authoritarianism? Financial, fiscal authoritarianism?

  18. The political parties should be educated on this history of popularity of stimulative policies which when done right provides multi-decade rule over austerity parties, which is all they care about.

  19. Again to look at Austerity in the modern (20th century and beyond) context, I believe that one has to see pre 1940 as economic global infancy and childhood, 1950 to 1995 as young adult, and 1995 onwards as the maturing adult global economy.

    Pre 1940 economies with respect to government were vastly different. Taxation levels were neglible compared to today’s taxation levels and that meant that governments of that time had relatively little leverage over their economies.

    What is the difference?

    The second world war required massive industrial mobilisation which triggered, I would argue, the industrial revolution stage 2. With the improved per person product output that followed that war people had higher relative incomes to support the higher step up of taxation levels resulting from the war. Along with that came a higher level of expectation of education/health care/social support which people came to appreciate as a result of the services provided during the war. And being a world war this flowed across many countries.

    So the 1950’s for industrialised nations where a period like no other in the history of the world. So it is wrong to think of this period as being a continuance of what can immediately before.

    1975 saw the beginning of the industrial revolution stage 3. This is when computers began to be introduced into manufacturing machinery. The ongoing acceleration of industrial output per person allowed the global (western) economy to further mature .

    2000 and onwards we move into a period of over expectation of government by their people. In this period the economies of the world appear to be flooded with cash and credit, and both people and governments over indulge.

    And I’m not sure how this ends.

    My point is that in each phase of our maturing global economy Austerity has very different effects.

  20. Yes the Amity Vile Horror is a real piece of work. Shlaes shows what you can do when you start with a conclusion and work backwards, with plenty of creativity and little regard for the truth, to concoct revisionist support. I always wonder if people like Shlaes actually believe stuff they create like that. Or is it all rather cynical and simply done as a good career move? Are they really drinking their own Kool-Aid?

  21. It was not until the outbreak of World War II in 1939 that fiscal policy was directed to the goal of mobilising all available resources. The resulting upsurge in economic activity, and the contrast with the Depression years, killed the idea of expansionary austerity, seemingly once and for all.

    I think that wartime rationing might be considered one form of “austerity” though, and in Britain rationing continued well after the war while they were laying the foundation of the welfare state, it might be worth a mention – contrasting this type of austerity with the neoliberal form

  22. Savage’s picture was a staple decoration of working class homes in New Zealand during his lirgetime

    “lirgetime”? I thought I was reasonably familiar with new Zealand slang, but I’ve never come across that one before.

  23. @Tim Macknay

    Rather than simply highlighting the typing error of ‘lirgetime’ for ‘lifetime’ surely you ought to be applauding the achievement of managing to hit the ‘r’ and ‘g’ keys while avoiding the ‘f’?

  24. The IMF published a large study on fiscal consolidation ( I can link it if anyone hasn’t read it already) and found that life is exactly as Keynes said it was.
    Cutting government Expenditure will dampen demand but in ‘good conditions this will be offset by lower interest rates and a lower exchange rate which in turns assists investment etc etc.

    However it does need good economic conditions. Ireland has tried Austerity three times and only once has it succeeded.
    As john Quiggin himself has written about Keynesian economics in good times means much tighter fiscal policy than classical economics which is pro-cyclical.

    There is nothing wrong with being neo-liberal or using the Washington consensus at the right times as at those times they are most certainly part of Keynesian policy.

  25. Suggestions:

    * repeat that Hilferding is a Social Democrat in the Hilferding paragraph.
    * repeat that we’re in a “new conservative leadership” in the next para.

    It’s tricky to keep your head around the unfamiliar names and politics.

    More generally – add some little examples of expansionary and austerian policies. For instance the 1930s CCC would be would be a great example for something expansionary. I’d go for four – say a monetary and a fiscal expansionist example, and a monetary and fiscal austerian example.

  26. Professor Quiggin writes: “It was not until the outbreak of World War II in 1939 that fiscal policy was directed to the goal of mobilising all available resources.” Does this mean that such policy was thus directed even before Pearl Harbor?

  27. Maybe the word ‘Pillock’ is?

    Is there some problem, Freelander? I have no interest in a slanging match, and I’m sure Prof Q doesn’t either.

  28. Leon Walras :You need to read Cole and Ohanian’s many papers on the great depression. Hoover had a very expansionary fiscal policy before Roosevelt too. It didn’t help. You conveniently forget that. Also, what about Valerie Ramey’s recent survey paper on the size of government spending multipliers? She gives a table of results from various researchers. They tend to be quite small.


    Hoover’s biggest deficit in any year (1932) was 4% of GDP. With NGDP falling ~45% between 1929 and 1933 the evidence simply does not support that often repeated fallacy.

  29. @sdfc

    And, of course, there is a great difference between a deficit which arises after an austerity program and which simply arises because revenue collapses as the economy collapses faster than any hairy chested (budgie smuggled) cutback, and a deficit that arises as a consequence of a stimulus (additional spending).

  30. Freelander

    I just find it incredible how often the Hoover ran expansionary fiscal policy lie is repeated.

    Accepting that he didn’t however means accepting that austerity policies have been tried and failed with disastrous consequences.

  31. Austerity policies too often result in unintended deficits because when you kill an economy revenue goes down quicker than GDP. The results then ‘prove’ that deficits don’t work. But only ‘prove’ that nonsense to idiots.

  32. One response to expansionary austerity that appears to be missing from the discussion is this: Yeah, Right.

    I’m not sure exactly how the psychology of economic thinking goes – I’ve got some ideas – but it seems to me that the general complexity of economics and the general inability to make good predictions means that people will believe anything with a bit of psychological resonance.

    Before accepting an economic “numbers” theory we want to have a real world mechanism that actualises the theory in economic activity. For example, people do buy more at cheaper prices – maybe not always, but enough to make the price mechanism work. The question we might ask the proponents of expansionary austerity is what their mechanism might be. The idea that when the government sucks a lot of money out of the economy and gives it to external creditors investors will suddenly crawl out of their bunkers and launch new businesses in a new profitable environment is clearly nuts. The only people who are likely to feel like this are in economically inverted niche industries like pawnbrokers, repo men, and pay day loan sharks. The story is crazy.

    Of course, if enough people actually believe that sacking workers, increasing taxes and reducing government spending will produce an economic optimum then it might just work. This is probably what’s going on in the mental faculties of the auterity proponents: Seeing the ideologically/morally improved economy, investors will forget the depressed conditions and get out there and do it. But in the real world, no.

    As an aside, this is similar to how I feel about Ricardian equivalence: (eg) who actually take the minor inflation estimate variations several years out into account in decisions, etc. These estimates are typically wrong anyway, and the decisions that they might influence are completely swamped by other factors.

  33. @Jim Birch

    Yes, betting it all on the Confidence Fairy, as Stiglitz and Krugman (and perhaps John Q) like to put it.

    Frankly if I were a business owner (who owned a proper business, not just my little tiny hobby business), I’d feel a great deal less confident under circumstances when governments were cutting programs, cancelling infrastructure spend, and letting public sector workers go. The deficits, of course, can and should wait to be addressed in the good times.

  34. @Jim Birch

    The other thing is that, bizarrely, in times of crisis when deflation is a real risk, there are often murmurs (or more) that spending needs to be curbed to keep inflation under control.

    Reminds me of Hunter S. Thompson’s line about Nixon having an uncanny ability to turn garden-variety problems (except, not even) into mindbending crises.

    Maybe that’s the plan?

  35. Well we are getting the opportunity to do some real life evaluation, as the ALP government has just announced the cutting of 3000 public sector jobs leading into budget deficit reduction. The other bunch have said that that should be 12,000 jobs.

  36. Dumbest. Promise. Ever.

    Apparently it makes the financial markets happy though (keeps rates low? safe place to buy bonds? public assets at fire-sale prices?) all of which seem like pretty cold comfort in the wider context.

  37. If you don’t do austerity, then you run up big deficits and nobody will lend to you, or at least not at rates you can afford?

    Spending when you need to is only really a problem when you are too scared to tax appropriately, especially during good times. Those who advocate austerity also push lower taxes.

    I think bracket creep is a wonderfully clever way of increasing the governments tax take during good times.

  38. I was trying to work out how John’s “austerity measures” or stimilus spending might apply to the European Union, and in particular, how a long run balance might come about if spending to get out of trouble was pursued. Luckily for me, Henry Ergas has put his view: in today’s Australian newspaper ( for those with a subscription. I read it at a coffee shop – someone with a subscription may like to post the full text, for study and research purposes. I think that’s permissible.)

    Some limits in John’s chapter about the confines of a nation or its currency might be in order. Or maybe about how a group of nations can get themselves into so much difficulty by poorly thought through agreements on currency and banking controls, that neither “austerity measures” nor stimulus packages will offer easy salvation.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s