“The economics profession advances by one confusing financial disaster at a time. A series of 19th-century banking crises in England and the United States inspired policy makers to create the modern central bank. Then came the Great Depression, a period of economic misery that existing ideas could not explain. John Maynard Keynes and the far more libertarian Friedrich Hayek spent the 1930s trying to make sense of the inexplicable economic data. In the process, they developed the two schools of thought that still dominate economic arguments. The Keynesians overwhelmed public discussion in the United States and Britain until the 1970s, when Hayek, along with Milton Friedman and his Chicago school, became more popular.
By the 1990s, the debates between these two radically different theories seemed to have abated. Economists seemed to have accepted a consensus view of the world, one in which the profession would provide technocratic, nonideological solutions. It seemed like the fulfillment of Keynes’s dream that one day economists would be like dentists: boring practitioners of an uncontroversial and undeniably helpful science.
Then the financial crisis ripped this consensus apart. When Cameron’s government began its austerity program, many of the world’s leading policy makers were behind him. That September, the International Monetary Fund formally endorsed his spending cuts, stating that “the plan greatly reduces the risk of a costly loss of confidence in public finances and supports a balanced recovery.” The British Office of Budget Responsibility also signaled that Cameron’s austerity approach would bring economic growth and reduce unemployment. In the 2010 midterm elections, U.S. voters flooded Congress with Tea Party-friendly candidates. Many carried the mandate to halt further government stimulus.
Since then, though, an increasing number of global economic policy leaders have turned on austerity. Earlier this year, in a remarkable joint statement, the I.M.F., along with the World Bank, World Trade Organization and eight other major economic institutions, warned that austerity was hurting global growth and raising unemployment. They asked the world’s major economies to embrace stimulus. Over the past few months, the I.M.F. and its deputy director, David Lipton, also have issued several suggestions that the British government soften its austerity program. Mervyn King hasn’t entirely disowned his earlier pro-austerity views, but he is no longer the policy’s enthusiastic booster. Toward the end of 2011, Posen finally persuaded the M.P.C., in a unanimous vote, to increase its bond-buying program by 75 billion pounds (about $120 billion at the time). Even King supported him.
Cameron and his chief financial-policy minister, Osborne, say they have only deepened their commitment to austerity. Osborne recently announced that while he had hoped austerity could end by 2015, it now looks as if the policy will continue until at least 2018. That is, if the Tories are in power. Recent opinion polls show that after years in a dead heat, the Labour Party now has a solid lead in popularity, though elections are more than two years away.
As long as it continues, this experiment offers some crucial lessons for the United States. So far, austerity has not significantly improved economic health. The plan to shrink the size of government did not generate a sudden surge of private-sector confidence and investment. For all its differences, Britain is similar enough to the United States to suggest that severely cutting government spending in America wouldn’t be enough to quickly speed up our own frustratingly slow recovery either. Advocates for greater stimulus in the United States frequently point to Britain’s dismal experience as proof that unemployment will fall and economic activity will rise if the government spends considerably more money. But demonstrating that austerity has failed does not prove that stimulus fixes everything. After a few years of growth, Japan’s economy has found itself back in a period of stagnation.
Adam Posen says that the challenge of economic policy at a time when the economic data are so unlike anything that has come before is that no one can be sure what will work. But he says that’s no reason for inaction. Our options, he argues, can be divided into three general categories: austerity, stimulus and doing nothing. He, like an increasing number of mainstream economists, believes we can now scratch austerity off the list. Doing neither stimulus nor austerity — which is basically what’s happening in the United States — isn’t working, either. So, he says, let’s try stimulus, even if we don’t know for sure it’ll do the job. Now he wants to persuade America that it’s the best shot it’s got.”