THOSE AREN'T THE TWO UNIQUE CONDITIONS THAT MATTER:

Keynes vs. Alesina. Alesina Who?: Economist Alberto Alesina argues that austerity triggers growth (Peter Coy, Business Week)

Alberto Alesina is a new favorite of fiscal hawks like former President George W. Bush's chief economic adviser, N. Gregory Mankiw. A professor of economics at Harvard University, the 53-year-old Italian disputes the need for more government spending to prop up growth and advocates spending cuts instead. [...]

Alesina's historical research, though, doesn't shed much light on what might happen if the U.S. adopts an austerity budget, because current circumstances don't resemble most of those in Alesina's database. It's rare for a nation to suffer such a big shortfall in demand that it cuts interest rates to zero, as the U.S. has. It's even rarer for a government in such circumstances to tighten its fiscal belt. Japan's experience is a cautionary tale. Japan attempted to tackle its deficit in the late 1990s during a period of weak demand and near-zero rates. Many economists say the move prolonged the slump that became known as Japan's Lost Decade. To be sure, Japan tried to balance its budget mainly by raising taxes, which is not Alesina's preferred solution.

Economists who describe themselves as Keynesians or neo-Keynesians don't buy Alesina's medicine. Gauti B. Eggertsson, a staff economist at the Federal Reserve Bank of New York, concluded in a paper last November that, with interest rates at zero, the right remedy is to raise government spending, not cut it. Espousing his own views and not those of the Fed, Eggertsson wrote that when extremely loose monetary policy isn't stimulative enough, "the goal of policy should be to increase aggregate demand—the overall level of spending in the economy."

Alesina's own research shows mixed results from deficit-cutting. He identified 26 examples since 1980 of deficit reductions that triggered growth of gross domestic product and 21 that lowered government debt substantially. He found only nine double victories in which government policymakers managed both to expand their economies and reduce debt. (Among them: Ireland in 2000, and the Netherlands and Norway in 2006).

Alesina is unfazed. While acknowledging that experience with zero-rate situations is scant, he says, "I don't see how anyone can argue that we should push even more on the fiscal accelerator." He says the greatest risk to global growth is a financial crisis brought on by fears of government overindebtedness.

What's unique, or at least unusual, about the current era is the complete dependence of the global economy on the debt of the one country that has a demographic future and the extended period of economic growth in a deflationary climate that we've been in for 30 years.

Posted by Orrin Judd at July 1, 2010 6:17 AM