Monday, May 21, 2012


It's hard for me to know exactly what the readership of this blog is, but at least notionally it's students of econ101ab, which recently had its final examination for 2011-12. Hopefully those who sat the exam and read the blog will carry on, and those who are more casual readers of this blog will also carry on - I'll keep posting sporadically over the summer, and of course pick up again in the Autumn and Winter when econ101ab comes around again.

In the meantime I thought I'd point out a blog post which suggests that "economists tell the EU" that "austerity isn't working".

This blog post is a great example of where you, as first year undergraduates, have already surpassed the understanding of many people in the blogosphere who claim to be qualified enough to talk about the economy. Generally also of the left or right, what they exemplify is an inability to make a coherent, logical argument, and also an inability to distinguish causality from correlation.

The main reason I highlight this is that these are two common failings of many arguments put forward by well meaning folk, undergraduate students included - I'd like to encourage you in your essays as you move through your degree to try and ensure you do none of these things!

The headline says "austerity isn't working", yet no attempt is made to actually establish that fact. It's assumed - like we're having a chat over a pint in the pub. Unemployment is cited as an important factor we need to be concerned about. For sure it is, but how does the blog article, or the pamphlet it is based on, establish that unemployment is caused by austerity? It points out that unemployment is up "since 2008", as if that is the clincher. That is a correlation. We cannot run the UK economy (or the EU one for that matter) since 2008 without the two large policy measures that took place - the stimulus packages of 2008 and the austerity that followed. So it's impossible to know; how do we know the stimulus package didn't set in motion the causal events that led to the increased unemployment?

Now the intent here is not to be deconstructive. What have we learnt in econ101b about the macroeconomy, and hence unemployment? A number of things; early in the course we talked about labour demand and labour supply; we can have cyclical bouts of unemployment, caused generally because real wages don't fall far enough to clear the market, as we would have in a normal demand-supply diagram for a market.

We also learnt about aggregate demand (AD) - the total level of demand in the economy is the sum of a number of things: private consumption (C), investment (I), government spending (G) and net exports (NX). We usually jump from there and say "look, increase G and we increase AD and everything is plain sailing!".

However, we do also discuss factors that help determine, for example, investment - it's a function of business confidence (b), interest rates (r) and potentially also of government spending (either as firms invest to meet demands of government or as they are crowded out - call it g).  So I is a function of confidence, interest rates and government spending in potentially unknown ways: I=f(b,r,g).

The large logical jump the blog article makes is that increasing (or not decreasing) G will solve all the problems in our macroeconomy. Now regardless of what you feel about austerity, and I am personally not particularly keen on it, a case has to be made for why it is bad, and unfortunately the blog article cited above doesn't do that (and neither does this, for space reasons!).

You have to make a number of assumptions about investment behaviour, about consumption behaviour and about the behaviour of the rest of the world in order to arrive at the conclusion that austerity is harmful and that instead we should be stimulating the economy. I'll try and set them out in separate blog posts over the coming days. All assumptions ought to be testable, meaning that it is not inconceivable that real world data could be brought to bear on this issue - which would be a refreshing change from much of the loud voices out there at the moment.