Thread: Reducing a deficit by 1% GDP reduces real incomes by 0.6% and raises unemployment by 0.5%    

Results of a study done by the IMF on the effects of fiscal austerity based on 173 examples in history. Conclusions may be obvious to some, but if one looks at policy making right now, one would get the opposite impression. The study found that: Reducing a deficit can often raise unemployment, particularly long term unemployment, and that those hardest hits by austerity are people who live on wages rather than rents, IE: main street vs. wall street.

Using this better measure, the evidence from the past is clear: fiscal consolidations typically have the short-run effect of reducing incomes and raising unemployment. A fiscal consolidation of 1 percent of GDP reduces inflation-adjusted incomes by about 0.6 percent and raises the unemployment rate by almost 0.5 percentage point (see Chart 2) within two years, with some recovery thereafter. Spending by households and firms also declines, with little evidence of a hand­over from public to private sector demand.

In economists’ jargon, fiscal consolidations are contractionary, not expansionary. This conclusion reverses earlier suggestions in the literature that cutting the budget deficit can spur growth in the short term.

The reduction in incomes from fiscal consolidations is even larger if central banks do not or cannot blunt some of the pain through a monetary policy stimulus. The fall in interest rates associated with monetary stimulus supports investment and consumption, and the concomitant depreciation of the currency boosts net exports. Ireland in 1987 and Finland and Italy in 1992 are examples of countries that undertook fiscal consolidations, but where large depreciations of the currency helped provide a boost to net exports.

Unfortunately, these pain relievers are not easy to come by in today’s environment. In many economies, central banks can provide only a limited monetary stimulus because policy interest rates are already near zero (see “Unconventional Behavior” in this issue of F&D). Moreover, if many countries carry out fiscal austerity at the same time, the reduction in incomes in each country is likely to be greater, since not all countries can reduce the value of their currency and increase net exports at the same time.

Simulations of the IMF’s large-scale models suggest that the reduction in incomes may be more than twice as large as that shown in Chart 2 when central banks cannot cut interest rates and when many countries are carrying out consolidations at the same time. These simulations thus suggest that fiscal consolidation is now likely to be more contractionary (that is, to reduce short-run income more) than was the case in past episodes.

The historical evidence also shows that fiscal consolidations based on spending cuts are less painful than those based on tax hikes. This is largely because central banks have cut interest rates more after spending cuts. Again, this avenue is not one that many countries can rely on today.

Fiscal consolidation may also seem less painful when markets are more concerned about the risk of a government defaulting on its debt. This could reflect so-called confidence effects: the fact that the country is tackling the fiscal situation can impart confidence to financial markets and to consumers and firms, leading them to spend more. But the IMF research found that even in such cases, on average, the effects are contractionary, with no evidence of any surge of consumption and investment.

Fiscal contractions raise both short-term and long-term unemployment, as shown in Chart 3, but the impact is much greater on the latter. Long-term unemployment refers to spells of unemployment lasting more than six months. Moreover, within three years the rise in short-term unemployment due to fiscal consolidation comes to an end, but long-term unemployment remains higher even after five years.

How does fiscal consolidation affect the distribution of income between wage-earners and others? The research shows the pain is not borne equally. Fiscal consolidation reduces the slice of the pie going to wage-earners. For every 1 percent of GDP of fiscal consolidation, inflation-adjusted wage income typically shrinks by 0.9 percent, while inflation-adjusted profit and rents fall by only 0.3 percent. Also, while the decline in wage income persists over time, the decline in profits and rents is short-lived (see Chart 4).

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Accordingly, fiscal measures that are approved now but kick in to reduce deficits only in the future—when the recovery is more robust—would be particularly helpful. Examples include linking statutory retirement ages to life expectancy and improving the efficiency of entitlement programs. In contrast, fiscal consolidations that are unduly hasty risk prolonging the jobless recovery in many advanced economies. So countries with the scope to do so should opt for a slower pace of consolidation combined with policies to support growth (Lagarde, 2011). In countries such as the United States, where unemployment remains at historical highs and long-term unemployment is at alarming levels, more active policies are needed to spur job creation and increase consumer confidence, including measures such as mortgage relief for distressed homeowners.

http://www.imf.org/external/pubs/ft/...11/09/Ball.htm

saw this in bg chat and instantly knew this was a kuya thread -_-

inc 4 pages of demos and repubs arguing

I don't think Numbers is behind this.

^beat me to it

lol

Time to invest in diapers. Babies always need diapers.

Report elaborates on social effects of unemployment:

Fiscal consolidations thus add to the pain of those who are likely to be already suffering the most—the long-term unemployed. This is a particular worry today since the share of long-term unemployed increased in most Organization for Economic Cooperation and Development countries during the Great Recession. And even in countries where it did not increase—such as France, Germany, Italy, and Japan—the share had already been very high even before the recession.

Job loss is associated with persistent earnings loss, adverse impacts on health, and declines in the academic performance and earnings potential of the children of displaced workers (see “The Tragedy of Unemployment,” in F&D, December 2011). These adverse effects are exacerbated the longer a person is unemployed.
Moreover, long spells of unemployment reduce the odds of being rehired. For instance, in the United States today, a person unemployed for more than six months has only a 1 in 10 chance of being rehired in the next month, compared with 1 in 3 odds for a person unemployed less than a month. The increase in long-term unemployment thus carries the risk of entrenching unemployment as a structural problem because workers lose skills and become detached from the labor force—a phenomenon referred to as “hysteresis” (Blanchard and Summers, 1986).

Long-term unemployment also threatens social cohesion. An opinion survey conducted in 69 countries around the world found that an experience with unemployment leads to more negative opinions about the effectiveness of democracy and increases the desire for a rogue leader. The effects were found to be more pronounced for the long-term unemployed.

What i want people to take from this study is that you can use it as a talking point when you get into an argument with someone involving austerity. You can even cite these specific numbers to convince other people that austerity is simply the wrong policy decision at this point in time. It's also important for people to read this and see that austerity has real and severe consequences and that it's worthwhile to get politically active about this sort of issue.

Austerity?

Wikipedia says:

In economics, austerity is a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided.[1] Austerity policies are often used by governments to reduce their deficit spending[2] while sometimes coupled with increases in taxes to pay back creditors to reduce debt.[3] "Austerity" was named the word of the year by Merriam-Webster in 2010.[4]