The open seat in NY-26 has gone to the Democrats, yet some conservatives still argue that despite its political unpopularity the GOP budget needs to be implemented because immediate and significant spending cuts can cause significant economic growth. But does this claim hold up? It turns out that conservatives are overstating the evidence from a key study they use to make this case and that the reality is much more sobering.
Conservatives and Republicans have attempted to find empirical evidence to support their belief that economic growth can come with austerity. They frequently cite a study done by Harvard economists Alberto Alesina and Silvia Ardagna. The study looked at what the best ways for countries to reduce their deficits have been: whether through spending cuts or revenue increases. Their data shows that over the long-term, spending cuts are a better way to bring long-term deficits under control. A second study by Alesina went further and argued that “large, credible and decisive” cuts can be immediately followed by “sustained” growth.
This study has since found its way into different strains of conservative and Republican literature. Jeff Sessions, the ranking Republican on the Senate budget committee released a white paper on May 12th that looked at “Fact-Based Budgeting” and included statements like this:
Indeed, a consistent and striking conclusion from a large and growing body of evidence is that successful efforts to climb out of debt are composed mostly of spending reductions, and that these reductions not only do not tend to harm economies but, rather tend to lead to economic growth.
So what’s problematic with Alesina’s results? Alesina has indeed found cases where reducing spending was followed by economic growth and reduced deficits. The problem: he found very few cases. More specifically he found 9 examples out of 107 attempts to reduce spending.
Even if we are more generous with our parameters, the data is still not an overwhelming majority. If we are only interested in times where reducing spending was followed by an economic expansion, the result is 26 cases. If we are interested in the number of times that reduced spending was followed by successfully reducing the deficit (doesn’t mean the economy had to grow!) we find 21 cases in his data.
Chad Stone, Chief Economist of the Center on Budget and Policy Priorities, very generously went through the study to provide the above numbers to FrumForum. The following are the six countries that have seen a reduction in spending followed by both economic growth and a reduction in the deficit, with the years noting when the policies were enacted:
New Zealand (1993, 1994)
Norway (1979, 1980, 1996)
A question for any policy maker then becomes: is America in 2011 in the same situation that the Netherlands, Norway, Sweden, or any of the other high-tax European or Scandinavian countries are in? Are any of their economic situations that led to those spending cuts being followed by lower deficits and higher growth anything like the situation America is currently in?
But perhaps more immediately problematic for conservatives is that when the IMF looked at these arguments they found that growth and deficit reduction occurred in countries where cuts in spending were accompanied with easing and looser monetary policy from central banks. This means those countries also had policies such as the conservative-derided quantitative easing (QE2). (The IMF’s report states: “it appears that the difference in monetary policy responses accounts for much, though probably not all, of the difference in output performance.”)
As David Beckworth noted: “Fiscal tightening coincided with a recovery only because monetary policy was easing.”
So the evidence for Republicans is much less heartening. It seems that reducing spending only causes economic growth in a minority of cases, and that in those cases, the reduction in spending needs to be off-set by a monetary policy that is expansionary. The GOP currently is in denial about how big the economic growth from spending cuts will be and opposed to monetary stimulus due to the intellectual capture of the party by gold-standard and hard money advocates.
And this is why some Republicans and conservatives will still support the GOP budget. They really do believe it will work, and the only thing that can make it better are higher interest rates.
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