Austerity Delusion: Why Economies Can’t Cut Their Way to Growth – The Guardian’s Insightful Editorial

Paul Krugman, the Nobel prize-winning economist, issued a prescient warning a decade ago about the misconceptions surrounding budget deficits and the influence of “bond vigilantes” and “confidence fairies.” According to this narrative perpetuated mostly by right-leaning politicians, governments needed to cut deficits to avoid bond vigilantes driving up interest rates. However, if they did implement such cuts, the “confidence fairy” would supposedly stimulate private spending to offset the loss caused by budget reductions. This narrative, though debunked as a fiction, persisted across the EU, Britain, and the US.

Subsequent events have proven Prof Krugman right. Austerity measures failed to spur economic growth, and the “confidence fairy” has proven to be as imaginary as a tooth fairy. Nonetheless, the political rhetoric surrounding deficit reduction continues to persist. Every major UK political party expresses a desire for economic growth, with the prevailing message being that economic growth can only be achieved by reigning in the deficit. In March, the Office for Budget Responsibility forecasted a 2% growth rate for the UK economy, a prediction now seen as wildly optimistic. The International Monetary Fund predicts two years of only 0.5% growth. The notion that economies can cut their way to growth is a dangerous delusion.

The recent resurgence of higher interest rates has revived concerns about public debt in western nations and the belief that market forces alone determine interest rates. However, the so-called bond vigilantes are a myth. The real issue lies in financial institutions’ speculative bets. Liz Truss encountered a crisis when pension funds began offloading UK bonds, triggering a surge in long-term interest rates and necessitating intervention from the Bank of England. Last month, a warning was issued regarding the similar threat posed by hedge funds to the US bond market.

Recently, Chancellor Jeremy Hunt highlighted the “difficult decisions” that lie ahead concerning public finances. He pointed to the recent sell-off of government bonds and the subsequent rise in yields, which would lead to higher debt interest payments. While central banks prevent governments from defaulting in their own currency, they tacitly support the notion that excessive spending by heavily indebted governments could provoke a bond market attack. Mr. Hunt’s message is clear: it is spending on the poor, rather than the rich, that needs to be reduced.

This week, economist Bill Mitchell blogged that significant cuts in recurrent spending would be necessary under Mr. Hunt’s self-imposed debt rule, unless businesses suddenly began investing at unprecedented levels due to the influence of confidence fairies. Even if the money for such investments were available, Prof Mitchell argues that the necessary workforce is lacking, unless there is massive migration or a rapid decrease in unemployment. The Labour party should take note.

Until 1984, the postwar consensus was that economic growth was achieved through fiscal stimulus via an enlarged budget deficit and passive interest rate policies, while regulation and price controls kept inflation in check. Nigel Lawson, Mr. Hunt’s predecessor, proposed the reverse approach: promoting growth by eliminating government regulations and reducing inflation through budget deficit cuts and aggressive interest rate hikes. Economics often relies on persuasive rhetoric to convince voters that bad policies can yield good results. This belief system collapsed in 2008 when governments injected trillions into the global economy to save it. However, the current crisis linked to inflation has caused the public, who had abandoned the old faith, to seek comfort in it once again. History suggests that these conversions are likely to be short-lived.