In one corner of the intellectual boxing ring is Stimulo. His fighting words: more economic stimulus. History and theory, he declaims, teach that governments should run much larger fiscal deficits in a downturn. In the other corner is the Cutback Kid, who delivers the opposite message: more austerity. He asserts that history and theory teach that governments should reduce their deficits. The two contestants for the Economic Policy Prize are in the midst of a long fight. Amazingly, they are both losing.
Stimulo has the open-hearted enthusiasm often associated with residents of the United States, for three decades known as the land of big fiscal deficits and small worries. His favourite example is the 1930s Great Depression, which only government spending could end. Now, almost four years after the collapse of Lehman Brothers, GDP growth remains slow and the unemployment rate high. The government deficit, he says, should be increased by as much as necessary to push the economy out of its current stagnation.
The Cutback Kid has a more restrained charm, the sort sometimes associated with suave European intellectuals. He praises the virtue of balanced government budgets: sound finances keep inflation far away, support the value of the currency and promote a strong economy by not stealing savings from the private sector, the source of durable growth. After four years of extraordinarily high government deficits, he says, it’s time to cut back.
There have been no knock-out blows. Neither stimulus nor austerity seems to work as predicted. The United States has tried stimulus and the UK austerity, but the results in both countries have been disappointing. The euro zone, which has tried less stimulus and more promises of austerity than either, has not done any better. Japan has been stimulating for years, without either recovery or inflationary disaster.
Here is a summary of the most recent round: Cutback Kid opens with a one-two punch – first Latvia, where punitive austerity is turning the suffering economy around, and then history, which shows that fiscal contractions often help restore economic growth, while large fiscal deficits usually have bad consequences. Stimulo is not deterred. He ducks Latvia – austerity isn’t really working there – and he punches back with examples of successful borrow-and-grow polices. Then he strikes hard with Greece, where austerity is crushing the economy.