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Austerity Does Not Grow the Economy

The Federal Reserve Board issued new projections for the economy last week, and they are not pretty. It projects the unemployment rate will still be 8.2 percent at the end of this year, 7.4 percent at the end of 2013, and 6.7 percent at the end of 2014. To put this in context, the unemployment rate peaked at 7.6 percent in the 1990-91 recession and never got above 6.3 percent in the 2001 recession. The Fed is projecting that seven years after the onset of the current recession, the unemployment rate will still be higher than at any point in the last recession.

This should have people alarmed and angry since it means that millions of lives will be ruined. Workers who are unable to find jobs will not be able to support families, contributing to stress and breakups.

The reason the economy is not creating jobs is simply that there is no source of demand to replace the demand created by the housing bubble. With nothing to replace this lost demand, companies see little reason to expand production and hiring.

Government spending is an obvious source of demand. However this spigot has been closed due to concerns over deficits. We have thousands of people in Washington who seem convinced that if the government would just stop spending money and lay off more employees then the private sector would respond with increased output and hiring.

While this might seem implausible on its face (what business hires people because the government has laid off school teachers or firefighters?), we no longer have to speculate about the impact of budget cuts and government layoffs, the United Kingdom is showing us.

The government elected last spring in the United Kingdom committed itself to rapidly reducing the size of its deficit. This government austerity was supposed to give a big boost to the private sector. It actually did the opposite. Growth has fallen to a near standstill. The IMF projects that the U.K. economy will grow by just 0.6 percent this year and an only slighter better 1.6 percent in 2013. This pace is not even fast enough to keep up with the growth of the U.K.’s labor market.

It would be good if the politicians in Washington could learn these basic facts about the British economy. They might then realize that deficit reduction destroys jobs, it doesn’t create them. There are times when we should be worried about the size of the deficit, but this is not one of them.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of False Profits: Recovering from the Bubble Economy.

This article originally appeared in Economic Intelligence.

More articles by:

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

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