Since the 1980s, when financial markets were deregulated, fiscal tightening has been the policy response to the fall-out from the collapse of a succession of increasingly serious asset bubbles \u2013 the 2008 financial crisis simply being the most recent of these. The idea is that when government deficits and debt are high, the logical response is to cut public spending or raise taxes in an effort to bring them down. Most recently, this fiscal tightening has taken the form of austerity – cuts to spending on public services, which have disproportionately hurt the worst off. <\/p>\n\n\n\n
This\nis in sharp contrast to the decades before, when fiscal tightening was used at\nthe top of the economic cycle to cool an over-heating\neconomy and curb inflation \u2013 and curiously, asset bubbles and financial crises\nwere very rare.<\/em><\/p>\n\n\n\n The\ntiming<\/em> of fiscal tightening, though, also has a strong political dimension: whilst it is clear from experience that such\npolicy will deepen and lengthen a recession \u2013 but can have beneficial effects\non an economy in expansion \u2013 this will always be a tricky idea to sell. <\/p>\n\n\n\n The reason for this is made all too clear in a 2007 Financial Times<\/em> interview \u2013 at the height of the boom before the 2008 financial crisis \u2013 when the then CEO of Citigroup, Chuck Prince, said: \u201cWhen the music stops\u2026 things will be complicated. But as long as the music is playing, you\u2019ve got to get up and dance. We\u2019re still dancing<\/a>.\u201d Similarly, in a speech at Mansion House, in June 2007, the then UK Chancellor Gordon Brown famously told the audience that the City of London was entering \u201can era that history will record as the beginning of a new golden age<\/a>\u201d.<\/p>\n\n\n\n This,\nhowever, is only half of the problem. Whilst attitudes like these make it\ndifficult to find support for tight fiscal policy during the boom, a recession\nwill immediately make government accounts look much worse. And this generates\npressure to \u201cdo something about it\u201d \u2013 often resulting in poorly-timed, and\nhence, counter-productive, austerity.<\/p>\n\n\n\n The\npersistence<\/em> of austerity as an idea and a policy therefore owes far more\nto human emotions \u2013 or, as Keynes branded them, \u201canimal spirits\u201d \u2013 than it does\nto sound economics. It offers an apparently obvious solution to the problem of\nhigh levels of public debt, and is an easy idea to sell: if you have too much\ndebt, stop spending so much. <\/p>\n\n\n\n Austerity also resonates with ethical and moral attitudes about debt \u2013 often being considered the \u201cpain\u201d required after the excesses of \u201cimmoral\u201d over-consumption, spending and accumulation of debt have been revealed.<\/p>\n\n\n\n This\nrather simplistic view of austerity, however, fails to consider the radically\naltered dynamics of public finances since the late 19th<\/sup> and early 20th<\/sup>\ncenturies, when governments assumed increasing responsibility for social\nsecurity; and income tax became an important source of public revenue. Prior to\nthis, governments mostly accumulated debts as a result of wars. Thus, likening\na state budget to that of a private household or business made far more sense\nthen than it does today. <\/p>\n\n\n\n Now\nthat social welfare forms an important part of the state\u2019s budget (the costs of\nwhich tend to increase during recessions) and the government relies on income\ntaxes for its revenues (which tend to fall when the economy is in a slump), the\nanalogy no longer makes economic sense.<\/p>\n\n\n\n It is important that any fiscal tightening is effected in a progressive way, such that \u201cthose with the broadest shoulders\u201d bear the greatest burden. Similarly, the power of the financial sector must be curtailed to dampen the amplitude of our economic cycles.<\/p>\n\n\n\n