Other than that, how was the policy, Mrs. Lincoln?
But let's back up a minute. This isn't something that's always true. In fact, it almost never used to be. Cutting spending, you see, shouldn't be a problem as long as you can cut interest rates too. That's because lower borrowing costs can stimulate the economy just as much as lower government spending slows it down. What happens, though, if interest rates are already zero, or, even worse, you're part of a currency union that means you can't devalue your way out of trouble?
Well, nothing good. House, Tesar and Proebsting calculated how much each European economy grew — or, more to the point, shrank — between the time they started cutting their budgets in 2010 and the end of 2014, and then compared it with what actually realistic models say would have happened if they hadn't done austerity or adopted the euro. According to this, the hardest-hit countries of Greece, Ireland, Italy, Portugal and Spain would have contracted by only 1 percent instead of the 18 percent they did if they hadn't slashed spending; by only 7 percent if they'd kept their drachmas, pounds, liras, escudos, pesetas and the ability to devalue that went along with them if they hadn't become a part of the common currency and outsourced those decisions to Frankfurt; and only would have seen their debt-to-GDP ratios rise by eight percentage points instead of the 16 they did if they hadn't tried to get their budgets closer to being balanced. In short, austerity hurt what it was supposed to help, and helped hurt the economy even more than a once-in-three-generations crisis already had.
That brings us to two final points. The first is that the euro really has been a doomsday device for turning recessions into depressions. It's not just that it caused the crisis by keeping money too loose for Greece and the rest of them during the boom and too tight for them during the bust. It's also that it forced a lot of this austerity on them.
Think about it like this. Countries that can print their own money never have to default on their debts — they can always inflate them away instead — but ones that can't, because, say, they share a common currency, might have to. Just the possibility of that, though, can be enough to make it a reality. If markets are worried that you might not be able to pay back your debts, they'll make you pay a higher interest rate on them — which might make it so that you really can't.
In other words, the euro can cause a self-fulfilling prophecy where countries can't afford to spend any more even though spending any less will only make everything worse. That's actually a pretty good description of what happened until the European Central Bank belatedly announced that it would do “whatever it takes” to put an end to this in 2012. Which was enough to get investors to stop pushing austerity, but, alas, not politicians.
It's a good reminder that you should never doubt that a small group of committed ideologues can destroy the economy. Indeed, it's the only thing that ever has.
That's true whether you're talking about the European politicians who pushed for the creation of the euro itself — they ignored the economists who warned them that it might turn out just as badly as it has — or the ones who pushed for austerity a few decades later. After all, it shouldn't have been a surprise that trying to balance your budget when interest rates were zero would end badly.
Economists have known that since the 1930s. Politicians, though, still wanted to do it, either because they thought deficits were morally, politically, or economically bad, and there was no shortage of supposed experts who were willing to tell them that they were right.
These right-wing economists produced study after study showing that countries had been able to successfully cut spending when central banks could offset that by cutting interest rates, and said that this proved that the same was true when interest rates were zero like they were at the time.
But no matter. Economists who had never bothered to learn this, or who had forgotten it, or who especially saw this as a good excuse to cut government spending they'd always wanted to kept saying it would work even as it kept failing.
That should be as big a scandal as anything else.