Austerity v. Stimulus: The Verdict Is In.


By Michael Califra

It has been more than four years since the global financial crisis hit. For the past two to three years governments have been trying to repair economies damaged in the aftermath of the worst economic disaster since the Great Depression. There were basically two approaches taken to get economies and jobs growing again. One was the Keynesian approach: when people stop spending for whatever reason, leading to a fall in demand and a contracting economy, government must spend more to take up the slack, even if it means adding to the deficit in the short term. The other approach, favored by Conservatives, was to reduce budget deficits by drastically cutting government spending in order to boost business confidence and get the private sector investing again.

Well, the verdict is in. We can now see which approach has been most effective.

Let’s take five economies – the United Sates and four countries that have pursued austerity most aggressively: Ireland, Britain, Spain and Greece. Prior to the financial meltdown in 2008, both Spain and Ireland had low public debt and budget surpluses; Greece had high levels of debt. Unlike Britain, whose conservative government chose austerity policies, Ireland, Spain and Greece, which gave up their own currencies for the euro, had austerity forced on them as a condition for loans needed to meet their credit obligations. Of these five countries only the US did not adopt severe austerity budgets as a way of restoring economic growth, relying instead on increased deficit spending. Here are the results:

(European statistics via Eurostat)


Savage deflation has caused the country’s standard of living to fall 20 percent from 2009. In March, Greek unemployment reached a record high of 21.9 percent. For the first time on record, more people between the ages of 15-24 were without a job than with one. Unemployment in that age group rose to 51.1 percent, twice as high as three years ago. Riots and political instability have been the result with voters recently upending the country’s political system in an election that saw the crushing defeat of the mainstream political parties blamed for the economic collapse. Parties representing the left and the far-right made significant gains as Greeks protested the austerity pact forced on the country by the European Union and the IMF in return for loans.  111,000 businesses closed in 2011 and many economists believe the country has entered an economic death spiral which will force it out of the eurozone .


The Spanish economy contracted 0.3% in the first quarter of 2012 over the previous quarter. The country’s unemployment rate is now 24.4 percent, the highest in Europe, an especially stark figure given that the government has not yet begun laying off public sector workers in any significant number. The unemployment rate among Spanish youth rose to 50.5 percent in January.  Budget cuts and a declining standard of living incited civil unrest in several cities earlier this year and the government is bracing for more protests this summer. Spain is the 12th largest economy in the world; a Spanish default would have a ripple effect across the globe, possibly causing a financial crisis similar to 2008.


Ireland has often been heralded as one country where austerity has been working, but the latest numbers show a different story. According to figures released by the government last month, GDP fell 0.2% in the final quarter of 2011, officially putting Ireland into recession. The unemployment rate was reported last week at 14.8 percent, the highest since the crisis began, fuelled during the first quarter by a large number of public sector layoffs due to budget cuts. The youth unemployment rate was 30.5 percent.


The only one of the group that didn’t give up its currency for the euro, yet that hasn’t made its austerity fare any better. The economy shrank 0.3 percent in the final quarter of 2011, plunging the country into its first double-dip recession since the 1970s. In April, manufacturing output declined 0.7 percent indicating that any hope of a quick recovery is fading fast. Most amazing all, the downturn in Britain has now lasted longer than the Great Depression of the 1930s. The unemployment rate stands at 8.3 percent with the rate among young people at 22 percent, but both numbers will certainly rise as the recession deepens.

United States:

The US has not taken the austerity path, at least not to the extent that the UK, Ireland, Spain or Greece have.  In 2009 congress passed and the president signed a $787 billion stimulus package to bolster demand in the economy. While conservatives in congress called it a waste of money, many prominent economists, including some inside the Obama Administration, argued that the size of the stimulus was barely half as big as it needed to be given the severity of a crisis that saw the GDP in the last quarter of 2008 crashing 8.9 percent. But in 2009, there was significant resistance in congress to more spending, with Republicans calling for the austerity and deficit reduction they insisted would inspire business confidence. Every Republican in the Senate and all but one in the House voted against the stimulus.

The Results:

When the American Recovery and Reinvestment Act, as the stimulus is formally known, was signed in February 2009, GDP growth was negative, almost to an unprecedented degree.  But as the chart below shows, the economy immediately responded, slowing more gradually before turning positive by middle of 2009 with growth reaching 3.9 percent in 2010. In the first quarter of 2012, the economy expanded 2.2 percent over the previous quarter. In short, the economy has grown every month since mid-2009.

Chart: Bureau of Economic Analysis

US unemployment peaked in October of 2009 at 10.1 percent but has been dropping since then, albeit slowly, to the current 8.2 percent. Unemployment among young people ages 16-24 is at 16.5 percent, down from a peak of 17.6 percent last summer. There has been private-sector job growth for 26 straight months and a milestone was reached recently when the economy recovered all the private sector jobs lost during the downturn.

But despite the stimulus, the economic recovery has been shackled by austerity at the state and local levels. Those governments shed 586,000 jobs since the financial crisis struck. If state and local governments, with more help from Washington, had not been forced to lay off teachers, police, firemen and other public sector workers, but had been able to maintain their level of public employment at December, 2008 levels, the unemployment rate today would already be down to 7.1 percent.

While unemployment, especially long-term unemployment, continues to be the major residual problem of the financial crisis, we are nowhere near the catastrophic levels of joblessness in Ireland, Spain or Greece, nor has the US economy entered another recession as in Britain. And although the stimulus had its greatest effect on the economy in 2009 and 2010, the non-partisan Congressional Budget Office estimates that the unemployment rate in the first quarter of 2012 was 0.1 to 0.8 percentage points lower than it would have been without it.

Yet, it turns out that the economists who argued for a bigger stimulus were right. If it had been twice as large, in the $1.2 trillion range that many were advocating, we would have been generating twice as many jobs and the GDP would be growing much faster than it is now. That increased economic activity would have generated more tax revenue for the Treasury and we would have already begun the process of growing our way out of debt. We had half the needed stimulus and are getting, in effect, half the recovery. But when you look at what budget-cutting austerity has wrought elsewhere, and consider the immense human suffering and corrosive societal effects of unemployment rates not seen in the industrialized world since the Great Depression, it is clear that that stimulating the economy was the right thing to do.

Some argue that austerity can’t be blamed for economic contractions in Europe because, in some cases, budget cuts haven’t fully taken effect, and in some places that is true. But since the whole idea behind cutting deficits is to inspire confidence, the simple fact that businesses know cuts are on the way should have had the same effect. Yet it hasn’t worked that way. The private sector in countries where austerity is being applied continue to shed jobs. And adding to the tragedy is the fact that skyrocketing unemployment and contracting economies caused by budget-cutting also decrease tax revenues to the point where the budget deficits austerity was meant to reduce actually increase instead.

So John Maynard Keynes has been vindicated. It’s a lesson that should have been learned from the economic history of the Great Depression.  Unfortunately, millions of suffering people are being forced to learn it yet again.


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