Politics can’t handle the Truth about Austerity

June 12, 2013

MY COMMENT: How do we deal with our situation? Years of fiscal deficit spending have become a matter of concern. Our national debt including heavy household borrowing is at an all time high and how long do policymakers and their political masters think we can postpone the day of reckoning. The forthcoming budget 2014 will reveal how the Najib administration intends to cope with the after effects of politically motivated and debt financed public spending of the last few years.

Accommodative monetary policy (low interest rate policy) cannot be relied upon to do the magic of sustaining economic growth since inflationary pressures are already being felt in all sectors of our economy.

“Fiscal stimulus is essential when conventional monetary policy is powerless. But fiscal stimulus isn’t always an option. Governments can’t do it if investors are unwilling to buy their debt,” says Economist Crook. 

For Malaysia, it has become critical for our government to recognise that debt financing to sustain economic growth is not an option without attendant risks. The need for fiscal prudence, therefore, cannot be overstated. We need fiscal strength for a rainy day.–Din Merican

Politics can’t handle the Truth about Austerity

by Clive Crook(06-o5-13)@http://www.bloomberg.com

What we know, or think we know, about fiscal policy five years after the global recession started isn’t all that different from what we knew, or thought we knew, back in 2008. It boils down to two points. One, fiscal stimulus is essential when conventional monetary policy is powerless. Two, fiscal stimulus may be impossible even when it’s essential.

Most economists agree that changes in interest rates are usually a better way to regulate demand than discretionary changes in taxes and public spending. But interest rates can’t fall to less than zero. When that limit is reached — as it was in this recession — fiscal policy must carry a bigger load.


In economies with a lot of slack, fiscal multipliers (the change in output that follows from any change in the fiscal balance) are more powerful than usual. This recession, because of its unusual depth, has supplied new evidence to back up this rule, and the UK’s attempt to refute the logic with “expansionary austerity” is widely seen as a failure despite some recent tentative signs of recovery.

Moreover, unconventional monetary policy, the other alternative to changes in short-term interest rates, can’t yet be called a success. Only when the Federal Reserve and other central banks end their vast asset-purchase programs will it be possible to render a verdict on quantitative easing as a partial substitute for fiscal stimulus. So far, it looks as though it has helped. Let’s see how the exit goes before we declare it a triumph.

Essential options

To repeat, fiscal stimulus is essential when conventional monetary policy is powerless. But fiscal stimulus isn’t always an option. Governments can’t do it if investors are unwilling to buy their debt. Greece and other European Union economies discovered this in 2010. Theirs was hardly a new experience.


Europe as a whole had, and still has, unexploited fiscal capacity. It chose not to use it for both good and bad reasons. The good reasons included the desire to force governments to reform their economies in ways they wouldn’t consider unless under pressure. The bad reasons included the idea that the worst-hit countries had brought their troubles on themselves, and shouldn’t look to their EU partners for help.

The right answer is plain, and has been from the start: collective EU fiscal support with conditions. The union has made gestures in that direction, but the scale of the response so far has been pitiful.

What about the view that governments don’t need to worry about fiscal capacity if they borrow in their own currency? A country like Greece can find itself literally unable to service its debts. The US or the UK, which borrow in their own currencies, could never be forced into that corner. They can simply print the money if need be. Or so it’s argued.

Countries that borrow in their own currency can, in fact, default. Put to one side the periodic threats from the US. Congress to repudiate debt as an act of policy. Beyond that, countries may resort to inflation as a way to lighten their debts, and investors are aware of the possibility. A surge in bond yields that would require sudden fiscal contraction is therefore possible even for a country like the US.

debt, debt, debt

A country that borrows in foreign currency has to keep debt at levels that cause investors no concern; for the others, that’s merely very desirable. Even for the US, heading into the next bad recession with a ratio of debt to gross domestic product of 40% would be a lot better than doing so with a debt that is 80% of GDP. Fiscal consolidation when the economy is strong is as important as fiscal stimulus when it’s weak: Without the first, you can’t count on the second.

Impossible coalitions

Another finding from the past five years: Building political coalitions around that simple precept — stimulus when necessary, consolidation when possible — has proved surprisingly hard. The right has mostly argued for austerity regardless. The left has mostly played down the need for fiscal control later, arguing that as growth resumes the problem will take care of itself.

This is the context that made the findings of Carmen Reinhart and Kenneth Rogoff on debt and growth so controversial. Conservatives seized on their finding that high levels of debt are correlated with lower growth, calling it proof that austerity is needed now, which is a non sequitur. Keynesians seized on an error in one of the authors’ papers and on the fact that correlation isn’t causation to imply that austerity is always dumb, also a non sequitur.

Carmen and Ken Rogoff

A recent open letter by Reinhart and Rogoff says all that needs to be said on their position and that of their critics. The point I’d stress is that, confounding the positions of the two warring camps, the link between debt and growth almost certainly runs in both directions.

The link from low growth to a high debt-to-GDP ratio is clear and immediate: In a recession, dwindling tax revenue and higher automatic outlays increase debt, and slow growth holds back GDP. The link from high debt to low growth is a bit more complicated but still pretty obvious: Higher interest rates crowd out private investment while mounting payments for debt service squeeze public investment and push up tax rates.

It’s silly to ask whether high public debt causes lower growth or vice versa as though it must be one or the other. Almost certainly, both are true. This reinforces the case for fiscal consolidation as the recovery strengthens — not just to restore fiscal room for maneuver but also to support longer-term growth.

What’s needed is fiscal strength (as conservatives stress) and the willingness to use it boldly when necessary (as Keynesians stress). This simple proposition was true in 2008 and it’s still true. It should be uncontroversial, but it seems to be more than politics can handle.

Clive Crook is a Bloomberg View columnist. To contact the writer of this article: Clive Crook at clive.crook@gmail.com.


14 thoughts on “Politics can’t handle the Truth about Austerity

  1. Din,

    Thank you. Unlike Physics, Economics offers very few examples that are counter-intuitive. Most economic notions are grounded on ‘first impression’ common sense. As a former central banker, schooled under the formidable Tun Ismail Ali, you might agree with this.

    Take the national debt, for example. Nothing wrong with borrowings, so long as they are put to good, productive use and that can be repaid over the stipulated time. The problem is that nation states borrow on favourable sovereign terms, and tend to get intoxicated with them. The borrowings are then put to unproductive use. When the Debt to GNP ratio gets beyond a certain point, and the rate at which the market will lend gets out of control, we are in trouble.
    Economics is organised common sense, yes. Financing BR1M (Bantuan Rakyat 1Malaysia) is not productive. Financing projects at inflated cost is another. That is why I am concerned about excessive and wasteful fiscal spending by the Najib administration.–Din Merican

  2. I never stop ranting here or anywhere that government is about JIGS:

    Increase Jobs, control Inflation, promote Growth and ensure Savings.
    Are we have more quality Jobs for middle income?
    Do our middle income earners have to pay more for daily needs (rental, energy and food)
    Have we increased GDP that are not reliance on CPO and Oil (compare to US farm payroll)?
    Have our reserve grown and our middle income earners able to save?

    How long more must we have a deficit budget? We don’t have deep pockets or debtors owing us trillions.

  3. Din,
    Forgive me for having such short patience in really reading all this article. Like I say before all these issues can be found in all the series of Yes Minister/Prime Minister. Even Wan Juandi complained that ministers must know his briefs & he quoted certain phrases from Yes Minister/ Prime Minister series.
    How to really tell the truth about austerity. Especially one got to vote in through popular demand. In a democracy, such words are echoed,

    ” Leaderships must be led by example. I am their leader. I must follow them”

    Just watch the series ” Climbing the Greasy Pole”. You would perfectly understand what I mean.

    Perhaps, I am just as so many including Maggie Thatcher so much influenced by these series would be very suspicious of people like Ghazali Shafie. Why? Just watch the series ” A victory for Democracy”. You would have understood. Perhaps, I would leave you with documentary……of course, I am not saying that you must fully agree with what’s transpired. But it has a very strong argument about……Hahahaha…..Just as the BBC portrayed very well how George V has set a very good exmaple of how a monarch should behave. I repeat again that our HRHs must watch it & embrace it. Better still adopt it or else.me for lese majeste…..I will drag the mightt

  4. To all these buffons including alie the cat, go ahead & make my day. I will bring BBC along, Try me! Najib & his wife won’t be welcome in London & Nortingham. Najib may not be invited by QE2. Wanna bet!

  5. ” …..people get intoxicated at ‘ borrowings…..and funds raised are put to unproductive use…..’ to that effect by Hamzah, which is usually the Bumiputra mentality about entrepreneurship ?
    The real problem, which I agree with Dato’ Din is ‘ project financing at Inflated Cost/s ….etc . This is done deliberately so that the difference between the ‘ real ‘ cost, and the inflated cost goes into private pockets…..and Malaysian consumers are the ultimate suckers…
    SO ITS PAY-BACK TIME NOW , all Malaysian Consumers.
    We need another Legendary icon like the late Tun Ismail Ali

  6. All Malaysian Consumers – forget about political affiliations – we have to watch the tab, follow closely the Consumer Price Index (CPI) in the Statistics Dept, for his first 2 to 3 years, and be shrewd about inflationary prices of all Consumer goods & items in the market ( thousands of consumer items, but the big ‘sharks’ esp TM, electricity, petrol prices, Astro or Mobile phone Cos…..etc ) , have a close watch and be FRUGAL, if need be misery. IF the prices shoot up this 3 years, then by ALL means, do everything the public can, go all out campaign for the Opposition PKR and make full preparations to overthrow the ruling incumbent, and for PR Govt to be in place @ GE 14…..This will be the final test, the final straw that breaks the camel’s back….

  7. Hah…there is no TUN like our late Tun Ismail Ali who said more NO than yes to TDM. Perhaps TUN Lim Chong Eu is close (they were good buddies old UK days as some of us know). TUN Ismail brought up many prudent people whom TDM rather they stay far away so those YES MINISTER gets the job.

  8. I am not an economist by profession but common sense tells me that if you borrow money and spends it on gambling or unproductive use and do it too often, you are doomed. You don’t need a PhD to understand this.

  9. We do have GREAT examples of Austerity as in Pakatan states. These state were prudently governed and have surplus.

    Who say we dont have competent governments? At state level, it is seen. At federal level……everything is in deficit including human capital.

    Ubah NOW ! If cannot get Pakatan in then Get Kuli in for all our children sake. This will make TDM fuming mad…haha

  10. Malaysian is general are worried dead on the ballooning deficits, and many older generation are seeing the problem and have become more frugal. But our “elected” gov does not seem to care much about the deficit, just this two weeks, the newly minted tourism minister is asking to increase his ministry’s budget to about RM700 million, from about 400, and the swap post minister of defence is asking to increase its ministry’s allocation to upgrade the facilities. Time for another spending spree by all these spoil brats.

  11. We better have KULI now before everything in this country makes no sense.

    However the complain about crime is serious but wait till you see Africans beating and burning their people alive……….real savage.

  12. Ku Li will bring in Bn mentality .He. Is part and parcel of the same corrupted regime.

    Probably guy like Khalid Ibrahim will inculcate some fiscal discipline.

  13. Data,
    My matey kaytee may have different opinion on Ku Li. In fact, to kaytee, Ku Li is more godly character than Anwar. Anything but Anwar so say kaytee. Khalid may be very good in managing finance but in politics, he’s one slimy fella. Never forgive him for stealing one deserved EXCO seat from DAP

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