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  • New Research Confirms that Spending Cuts Stimulate the Economy


    New research suggests that legislators should cut spending and enact growth-inducing policies. The reasoning? According to the study, spending cuts can positively affect economic growth and are the only historically reliable way to lower deficits and debt.

    The authors of the study, Alberto Alesina and Francesco Giavazzi, write that “spending-based consolidations [spending cuts] accompanied by the right polices tend to be less recessionary or even have a positive impact on growth.” (emphasis added)

    These findings confirm what was certainly true in past U.S. recessions.

    Alesina and Giavazzi also add that “only spending-based adjustments have eventually led to a permanent consolidation of the budget, as measured by the stabilization—if not the reduction—of debt-to-GDP ratios.”

    No ordinary person needs a study to know that when government spends less of our money it will be better for the economy, and that less spending means less debt. Yet this proposition seems bewildering to many intellectuals who maintain that spending cuts would bring economic ruin. After all, they say, look at how pointlessly damaging European spending cuts have been.

    Paul Krugman, for instance, concludes that the European example illuminates how “slashing spending in a depressed economy depresses the economy even more.”

    But Europe has gone beyond cutting spending; it’s also hiked tax rates, which everyone agrees is contractionary. Alesina and Giavazzi’s study cautions that one must disentangle whether spending reductions, tax hikes, both, or neither cause hardship. Indeed, drawing conclusions like Krugman does—without discerning between spending cuts and tax hikes—is like observing an individual who consumes pizzas, sodas, burgers, and broccoli and concluding that broccoli is unhealthy and making him overweight. It’s careless analysis.

    Sloppy economics lumps both spending and taxes together; proper economics analyzes them separately as well as together. Once discerned, it’s clear that the composition of “austerity” matters: Tax hikes contract an economy; spending cuts grow an economy.

    Posted in Economics [slideshow_deploy]

    4 Responses to New Research Confirms that Spending Cuts Stimulate the Economy

    1. Dan Phillips says:

      Ronald Reagan said that "Entrepreneurs and their small enterprises are responsible for almost all the economic growth in the United States."
      Take this cutting taxes and spending and you can see why we had the best economy of our lifetime while he was in office and after.
      There is a new book out titled "The Last Will and Testament of Small Business" that describes very well what it will take to pull us out of the Depression we are in now.

    2. Blair Franconia, NH says:

      The Democrats, including Obama, Reid, and Pelosi, don't think so.

    3. Tim says:

      "Spending-based consolidations [spending cuts] accompanied by the right polices tend to be less recessionary or even have a positive impact on growth." In the very next line of their article, Alesina and Giavazzi say that, "These accompanying policies include easy money policy, liberalisation of goods and labour markets, and other structural reforms." I don't see where we're ever going to get easier money policies from the ECB. Open market operations? But at the zero lower bound that does little good (QE anyone?). Raising the inflation target? Not as long as Germany has any say in the matter (and who would believe the ECB if they raised the target anyways?). Taking on more risk? Now we're bumping into fiscal policy…The only way I see austerity working absent any changes in monetary policy, which appears to be a precursor for the austerity defense from Alesina and Giavazzi, is if it somehow boosted investors' confidence in sovereign debt. Karl Smith tackled this question in October of last year: (http://modeledbehavior.com/2011/10/08/more-on-bl-mp/).

    4. Chris Coovert says:

      The article doesn't come close to saying what you think it says. It says that if you are trying to cut deficits it's better to cut spending than to raise taxes, at least in Europe where taxation is high. It admits this may be different in the US where taxation is low. It also doesn't even address the possibility that pro-growth policies (increasing spending and/or lowering taxes) might actually be the best way to balance the budget.

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