A Manifesto for Economic Sense

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More than four years after the financial crisis began, the world’s major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.

These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.

  • The causes. Many policy makers insist that the crisis was caused by irresponsible public borrowing. With very few exceptions – other than Greece – this is false. Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The collapse of this bubble led to massive falls in output and thus in tax revenue. So the large government deficits we see today are a consequence of the crisis, not its cause.
  • The nature of the crisis. When real estate bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but – just like the similar response of debtors in the 1930s – it has proved collectively self-defeating, because one person’s spending is another person’s income. The result of the spending collapse has been an economic depression that has worsened the public debt.
  • The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending. At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, that’s exactly what many governments are now doing.
  • The big mistake. After responding well in the first, acute phase of the economic crisis, conventional policy wisdom took a wrong turn – focusing on government deficits, which are mainly the result of a crisis-induced plunge in revenue, and arguing that the public sector should attempt to reduce its debts in tandem with the private sector. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing and exacerbating the dampening effects of private-sector spending cuts.

In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy – while it should do all it can – cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.

How do those who support present policies answer the argument we have just made? They use two quite different arguments in support of their case.

The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.

But there is no evidence at all in favour of this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank. This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies here have had no effect on Japanese interest rates. Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected.

Moreover past experience includes no relevant case where budget cuts have actually generated increased economic activity. The IMF has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. In the handful of cases in which fiscal consolidation was followed by growth, the main channels were a currency depreciation against a strong world market, not a current possibility. The lesson of the IMF’s study is clear – budget cuts retard recovery. And that is what is happening now – the countries with the biggest budget cuts have experienced the biggest falls in output.

For the truth is, as we can now see, that budget cuts do not inspire business confidence. Companies will only invest when they can foresee enough customers with enough income to spend. Austerity discourages investment.

So there is massive evidence against the confidence argument; all the alleged evidence in favor of the doctrine has evaporated on closer examination.

The structural argument. A second argument against expanding demand is that output is in fact constrained on the supply side – by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is just not the case. Every major sector of our economies is struggling, and every occupation has higher unemployment than usual. So the problem must be a general lack of spending and demand.

In the 1930s the same structural argument was used against proactive spending policies in the U.S. But as spending rose between 1940 and 1942, output rose by 20%. So the problem in the 1930s, as now, was a shortage of demand not of supply.

As a result of their mistaken ideas, many Western policy-makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root. But we can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment.

Better policies will differ between countries and need detailed debate. But they must be based on a correct analysis of the problem. We therefore urge all economists and others who agree with the broad thrust of this Manifesto to register their agreement at www.manifestoforeconomicsense.org, and to publically argue the case for a sounder approach. The whole world suffers when men and women are silent about what they know is wrong.

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Aaron Goldzimer – Stanford Graduate School of Business / Yale Law SchoolAlan Manning – London School of EconomicsAlan Maynard – University of YorkAlan S. Blinder – Princeton UniversityAlasdair Smith – University of SussexAlfonso Lasso de la Vega – Former Deputy Director in UNCTADAli Rattansi – Professor, City University, LondonAndrew Graham – Oxford UniversityBarbara Petrongolo – Queen Mary University and CEP (LSE)Barbara Wolfe – University of Wisconsin-MadisonBarry Bluestone – Northeastern UniversityBarry Supple – University of CambridgeCharles Wyplosz – The Graduate Institute, GenevaChris Pissarides – London School of Economics and Political ScienceChristian Kroll – University of Bremen / Jacobs UniversityChristopher Allsopp – Director, Oxford Insitute for Energy Studies, Oxford Colin Thain – University of Birmingham, UKDavid Blanchflower – Dartmouth CollegeDavid Hemenway, economist – Harvard School of Public HealthDavid Sapsford – Edward Gonner Professor of Applied Economics (Emeritus), University of LiverpoolDavid Soskice – University of OxfordDavid Vines – Oxford UniversityDemetrios Papathanasiou – The World BankDonald R. Davis – Columbia University, Dept. of EconomicsEric van Wincoop – University of VirginiaErzo F.P. Luttmer – Dartmouth CollegeG C Harcourt – University of New South Wales, School of EconomicsGary Mongiovi – St Johns University, New YorkGeoffrey M. Hodgson – Professor, University of Hertfordshire, UKGeraint Johnes – Lancaster UniversityGianni Zanini – World Bank (Consultant; former Lead Economist)Hannes Schwandt – CEP/LSE and Universitat Pompeu FabraHeinz Kurz – University of Graz, AustriaJ. Bradford DeLong – U.C. BerkeleyJan-Emmanuel De Neve – University College London & LSE Centre for Economic PerformanceJeffrey Frankel – Harvard UniversityJeremy Hardie – LSE Centre for Philosophy of Natural and Social ScienceJoan Costa Font – London Sschool of EconomicsJocelyn Boussard – European CommissionJohn H Bishop – Cornell UniversityJohn Van Reenen – Centre for Economic Performance, LSEJonathan Portes – National Institute of Economic and Social ResearchJoseph Gagnon – Peterson Institute for International EconomicsJustin Wolfers – Princeton UniversityKalim Siddiqui – Business School, University of Huddersfield, UKKen Coutts – Faculty of Economics, University of CambridgeKevin ORourke – University of OxfordLarry L Duetsch – Emeritus Prof of Econ, U of Wisconsin – Parkside Lesley Potters – European CommissionMarcus Miller – Warwick UniversityMariana Mazzucato – University of SussexMark Setterfield – Trinity College, ConnecticutMark Stewart – Warwick UniversityMax Steuer – London School of EconomicsMichael Ambrosi – Professor Emeritus, University of TrierMichael Graff – ETH Zurich and Jacobs University BremenMichael Waterson – University of WarwickNathan Cutler – Harvard Kennedy SchoolNattavudh Powdthavee – University of Melbourne and Centre for Economic Performance, London School of Economics and Politcal SciencesNicholas Rau – University College LondonOlaf Storbeck – Handelsblatt – Germanys Business and Financial DailyOriana Bandiera – London School of EconomicsP.E. Hart – Emeritus Professor of Economics,University of ReadingPatricia Rice – University of OxfordPaul Anand – Open University/ HERC Oxford UniversityPaul Gregg – Professor, Dept of Social and Policy Sciences, University of BathPaul Krugman – Princeton UniversityPaul Whiteley – University of EssexPeter E. Earl – University of QueenslandPeter Elias – University of WarwickPeter J. Hammond – University of WarwickPeter Taylor-Gooby – University of KentPeter Temin – MITPhilip Arestis – University of CambridgePhilippe Martin – sciences po (paris)Professor Sir Richard Jolly – Institute of Development StudiesRaffaella Sadun – Harvard Business SchoolRaja Junankar – University of New South Wales, University of Western Sydney, and IZARaquel Fernandez – NYURichard J. Smith – Faculty of Economics University of CambridgeRichard Jackman – London School of EconomicsRichard Layard – LSE Centre for Economic PerformanceRichard Murray – former chief economist, Swedish Agency for Public ManagementRichard Parker – Harvard UniversityRick van der Ploeg – University of OxfordRobert A. Feldman – IMF and Adjunct Professor Georgetown U. (retired)Robert H. Frank – Cornell UniversityRobert Haveman – University of Wisconsin-MadisonRobert Neild – Emeritus Professor,Trinity College, Cambridge Robert Pollack – Boston UniversityRobert Skidelsky – Wawick UniversityRoger Middleton – University of BristolRoger Stephen Crisp – St Annes College, OxfordRonald Schettkat – Schumpeter School, University of WuppertalSergio Rossi – Department of Economics, University of Fribourg, SwitzerlandShaun P. Hargreaves Heap – University of East AngliaSheila Dow – University of Stirling (emeritus position)Simon Wren-Lewis – Oxford UniversityStefan Szymanski – University of MichiganStephen E. Spear – Carnegie Mellon UniversityStephen Gibbons – London School of EconomicsSusan Himmelweit – The Open University, UKTerry Barker – University of CambridgeTony Venables – University of OxfordVictor Halberstadt – Leiden UniversityWendy Carlin – UCLWilliam Brown – University of CambridgeWilliam T. Dickens – Northeastern University and The Brookings Institution