Richard Murphy shows how not to argue against Osborne’s fiscal austerity. He writes:
Expansionary fiscal contraction is what is called a ‘general equilibrium model’ based on the ideas of neoliberal economics…
[Osborne] really does think we should all be dancing in the streets and borrowing money to spend now to celebrate the fact that he’s going to give us tax cuts with absolute certainty in the future.
This, though, is just bad history. Osborne’s policy is not based upon general equilibrium thinking. He wouldn’t know a DSGE model if it were to hit him in the face - something I’d pay good money to see. The paper (pdf) Richard cites is an example of economists seeing something work (occasionally) in practice and wondering how it might work in theory. It is not the basis of interest in expansionary fiscal contraction. Instead, that basis is the empirical fact that sometimes (pdf) - and only sometimes (pdf) countries have tightened fiscal policy and experienced surprisingly good growth.
Which brings me to how I would argue against the notion of expansionary fiscal contraction. There are mechanisms through which this can happen. But the simple fact is that they don’t seem to apply here and now. For example:
“Fiscal tightening can reduce long-term interest rates and so encourage firms to borrow to invest.” But as a simple fact non-financial firms are barely borrowing at all from either capital markets or banks, and are not stepping up their investment.
“Tightening can be offset by a lower exchange rate (pdf) or by looser monetary policy." However, sterling’s trade-weighted index has been more or less stable since early 2009, and with interest rates at their zero bound, any further monetary expansion must take an experimental form.
“Tightening can encourage firms to invest by reducing the demand for labour and wage militancy (pdf).” But whilst wage militancy might have deterred firms from investing in some countries in the 70s and 80s, it certainly was not a factor behind UK investment decisions in recent years.
“Tightening can be offset by increased personal borrowing.” This needn’t be because of Ricardian equivalence, but simply because - as in the UK in 1981 - fiscal tightening is accompanied by a relaxation of credit controls. Again, though, the facts speak against this. Whilst households are borrowing, they are not borrowing much.
In other words, doubts about Osborne’s policy should be based in the facts, not in some theory to which he doesn’t subscribe
Now, I don’t say this to criticise Richard; I can leave that to others. Instead, I do so for two reasons.
One concerns how we go about persuading others. Laughing at a silly idea and using the boo-word “neoliberal” might win cheers from your own side. But it does nothing to convince supporters of fiscal austerity who’ll simply think you’re attacking a straw man.
The other concerns the nature of economics. For me, economics is not about big ideas such as "neoliberal" economics. Instead, it’s about data and mechanisms; mathematical models are useful insofar as they draw attention to mechanisms and their likely importance. The fact is that there are some mechanisms which suggest that expansionary fiscal contractions can work. But there are also facts which suggest it is not doing so here and now.