Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Austerity Zombies Fight Back

Erskine Bowles
Julia Schmalz | Bloomberg | Getty Images

Perhaps my declaration of the death of austerity was a bit premature.

Yesterday I noted that both Jim O'Neil at Goldman Sachs and Bill Gross at Pimco have become publicly critical of both the theory and practice of austerity. This seemed to me to be at least the beginning of the end of the economic program that has gripped so much of the world since the end of the financial crisis.

The theory behind austerity was roughly grounded in the work of Kenneth Rogoff and Carmen Reinhart, whose 2010 paper "Growth in the Time of Debt" seemed to demonstrate that economies sharply slow when a nation's debt-to-GDP ratio hits 90 percent.

I say "roughly" because Rogoff and Reinhart weren't austerity's creators—they simply provided a convenient economic justification for what is in fact a political program.

That theory, of course, now lies in tatters. A much talked about paper by three researchers at the University of Massachusetts found serious errors in the Reinhart-Rogoff paper. There appears to be no magic debt ratio that automatically triggers an economic slowdown. Indeed, the causation probably often runs the other way: Nations with slowing economies build up public debt as tax revenues fall, and public spending rises because of automatic stabilizers and stimulus attempts.

Intellectually, then, austerity should be dead. But like a character from the "Walking Dead," brain death is apparently no obstacle to the march of austerity.

Here's one of the gurus of austerity, Erskine Bowles, reacting to the U Mass paper.

"I have obviously read the report and have referenced it a number of times," Bowles said. "I know they had a worksheet error in the report, and my understanding is that does make a difference.

"But what it doesn't change is the common sense and my own personal experience in both the public and private sector that when any organization has too much debt that is an enormous risk factor, and your risks go up, then people lending you money will want more money for their money," he said.

"My best guess is that whether the 90 percent number is the number or not, I don't know," he said. "That is obviously up to question. But the fact that adding more leverage to a company or a not-for-profit or a government's balance sheet does increase risk and therefore increases the return that somebody is going to expect on their capital is absolutely a fact."

Except that's absolutely not a fact. We've added massive amounts of leverage to the government balance sheet, more than tripling the debt since the turn of the century. The average interest rate on the federal government's interest-bearing debt has fallen from 6.537 percent in January 2000 to 1.992 percent today. The link between public debt and "the return that somebody is going to expect on their capital" just doesn't exist.

Lloyd Blankfein is also going to bat for austerity. From the BBC:

In an interview with the BBC, he said he would like it if the U.K. could ease the pace of the squeeze on spending.

But Mr. Blankfein, Goldman's chairman and chief executive, said if you have a deficit, that choice is taken away from you because markets will react. He said the U.K. must stay the course.

"You would like at this part of the cycle not to cut, to push out austerity and not to shrink the economy," Blankfein said.

"But if you have a big deficit you lose that optionality. The choices get taken away from you."

This is almost sad. Blankfein, it seems, is still reading from the discredited austerity script. Some aide should write him a memo on the U Mass paper before he says anything else embarrassing.

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