The failure of Austerity

One lesson that the world has learned since the financial crisis of 2008 is that a contractionary fiscal policy means what it says: contraction. Since 2010, a Europe-wide experiment has conclusively falsified the idea that fiscal contractions are expansionary. August 2011 saw the largest monthly decrease in eurozone industrial production since September 2009, German exports fell sharply in October, and now-casting. com is predicting declines in eurozone GDP for late 2011 and early 2012.

A second, related lesson is that it is difficult to cut nominal wages, and that they are certainly not flexible enough to eliminate unemployment.

Basically, European experience is very consistent with a Keynesian view of the world, and radically inconsistent with various anti-Keynesian notions of expansionary austerity and flexible prices.

The crisis really has settled some major issues in economics. Unfortunately, too many people — including many economists — won’t accept the answers.

This is a rather fundamental point. Not just economists, of course, but think-tank ideologues, politicians and general hangers on are awash with notions of how such-and-such will happen if you do such-and-such. The difference between evidence-based theories and hackish ones, however, is the part about being evidence-based.

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