Blogging the Zombies: Expansionary Austerity – Birth

by John Quiggin on November 22, 2011

Another instalment in the new  draft chapter on Expansionary Austerity, which I’m writing for the paperback edition of Zombie Economics. Comments and criticism much appreciated


Austerity measures of various kinds have been advocated, and implemented, in a wide variety of contexts. The term is used particularly in contexts like that of the present day, where government budget deficits arise as a result of (or at least in the context of) a recession, and where  it is proposed to return to budget balance through some combination of lower expenditure and higher taxes, usually with an emphasis on the former.

‘Austerity’ can also be used more generally, to apply to any situation where governments seek to reduce levels of public debt by running budgeted surpluses.  A notable example, with which the term ‘austerity’ is particularly associated, was that of Britain in the years after 1945. Victory in World War II had come at a huge cost. Britain was heavily indebted, particularly to the United States, and much of its overseas wealth had been destroyed. In these circumstances, there was little alternative to a policy designed to reduce imports, through rationing of a wide range of goods including food, and to maintain budget surpluses.

Nevertheless, the austerity of the 1940s and early 1950s was combined with policies that laid the foundation for widely-shared postwar prosperity. For the first time since the early 20th century, full employment was achieved and maintained for several decades. The National Health Service, which provided free medical and dental care to all was established, along with many other programs of the postwar welfare state.

The critical difference between these policies and the austerity programs now being adopted in Britain and elsewhere was the fact that they were introduced at a time of full employment, sustained by demand that had been suppressed during the war years and by expansionary monetary policy.  The result was that austerity policies, combined with devaluation succeeded in restoring external balance and reducing the ratio of public debt to national income. By contrast, under conditions of high unemployment, austerity measures reduce aggregate demand, and lead to further waste of resources through unemployment.

From the viewpoint of believer’s in Say’s Law, this distinction is meaningless. According to Say’s Law, unemployment can never arise through a deficiency in demand. It follows that, whenever government budgets are in deficit and public debt is excessive, austerity is the appropriate response. By reducing public demands on capital markets, it is claimed, austerity will make it easier for provide firms to investment. Thus, austerity is presented as an expansionary policy that will promote economic growth.

This idea of expansionary austerity can be traced at least as far back as the ‘Treasury View’ which determined the official policy response to the Great Depression in Britain. The most famous statement of the Treasury view is that of Winston Churchill, then Chancellor of the Exchequer, who defended

the orthodox Treasury doctrine which has steadfastly held that, whatever might be the political and social advantages, very little additional employment, and no permanent additional employment can, in fact, and as a general rule, be created by state borrowing and state expenditure” (House of Commons 1929, p. 54).

In his Budget speech of that year

“The orthodox Treasury view … is that when the Government borrow[s] in the money market it becomes a new competitor with industry and engrosses to itself resources which would otherwise have been employed by private enterprise, and in the process raises the rent of money to all who have need of it.” 

The Treasury view, stated in this way, is a restatement  of Say’s Law, or, in more modern terminology, the claim that public expenditure, by driving up interest rates (the “rent of money”) will always crowd out an equal amount of (typically more productive) private investment or private consumption.

There was, in a sense, nothing new in the Treasury view except the need  to offer an explicit statement of what had been, for most of the 19th century, an unchallenged orthodoxy.  As the chronic unemployment of the 1920s deepened into the Great Depression in 1929, the Liberal Party, supported by John Maynard Keynes advocated public works to stimulate the economy. 

The Treasury opposed these policies. This was partly because of their adherence to the classical model of macroeconomics, now described as the Treasury view, in which sustained unemployment could only arise as a result of problems specific to labor markets, such as minimum wages or recalcitrant unions. 

Underlying their opposition to fiscal stimulus, however, was a fear, entirely justified in its own terms, that an interventionist macroeconomic policy would pave the way for intervention in other areas and for the end of the liberal economic order based on the gold standard, unregulated financial markets and a minimal state. These fears were to be realised in the decades after 1945, when the combination of full employment and Keynesian macroeconomic management provided supported for the expansion of the welfare state, tight control of the financial sector and extensive government intervention in the economy.



UnlearningEcon 11.22.11 at 8:12 pm

As a related note of interest, it seems the reason unemployment was so low in post-WW2 austerity was because short and long term interest rate were pushed right down by policymakers based on the advice of Keynes.


Kevin Donoghue 11.22.11 at 8:34 pm

I wouldn’t quarrel with this as an introduction to the topic. But although I’m no expert, I’m pretty sure the following qualifiers apply:

(1) Classical economists did acknowledge the value of “public works” as a palliative for unemployment. As Keynes remarked, they advocated more sensible policies than their theories could support. Also, maybe J. S. Mill’s Of the Influence of Consumption on Production is worth a mention? Maybe it breaks the flow, but it’s only fair to note that the 19th century classical view was more nuanced than that of, e.g., Fama and Cochrane.

(2) The Treasury View was the work of officials who had been asked to assist Churchill with talking points. (Joan Robinson wrote about this somewhere or other and she remarked in passing that Churchill’s request was contrary to prevailing norms.) I’m not sure that anyone actually believed in it (Hawtrey surely didn’t).

And for the final paragraph it might be worth mentioning Kalecki, who seems to me to have understood the resistance to Keynesian ideas better than Keynes did.


Tim Wilkinson 11.22.11 at 8:45 pm

I would guess that that’s the expansionary monetary policy John mentions.


Tim Wilkinson 11.22.11 at 8:48 pm

Proofing: Pa 5, starting ‘From the viewpoint of believer’s in Say’s Law’, has make it easier for provide firms to investment


Down and Out of Sài Gòn 11.22.11 at 9:32 pm

How much did government take up the slack in post-WW2 societies, UnlearningEcon? Most of the soldiers would have been demobbed after 1945, but not all – and there had to be someone to hand out the ration cards.


UnlearningEcon 11.22.11 at 11:27 pm


Not to derail too much, but my point was it was more explicitly low long term rates than simple ‘expansionary monetary policy’. They made a credible commitment and stuck to it. Expansionary monetary policy is more vague and monetarists consider low rates a sign of tight rather than loose money.


gordon 11.22.11 at 11:40 pm

Perhaps only marginally relevant, but I like Robert Skidelsky’s suggestion of direct Govt. investment expenditure maybe via a Govt. bank:

“In fact, the best option of all is for the government to spend the money itself. Governments can do this consistently with a medium-term deficit-reduction plan by making a crucial distinction between their budgets’ current and capital accounts. The current account covers spending on services and perishable goods that produce no assets. The capital account is for buying or building durable assets that give a prospective future return. The first is a charge on taxation; the second is not.

“If today’s accounting rules are too insensitive to make this distinction, a separate entity could do the investing. A national investment bank would be capitalized by the government, borrow from the private sector, and invest in infrastructure, housing, and “greening” the economy. This would simultaneously plug a hole in demand and improve the economy’s long-term growth prospects. There are signs that officials in the UK and the United States are starting to move in this direction”.

I don’t remember seeing a Govt. bank seriously suggested since the dark days of late 2008/early 2009.


StevenAttewell 11.23.11 at 12:29 am

I’d also throw in that 40s and 50s austerity was also tied to labor regulations that protected and empowered workers organizations – organizations that were vital in tying wage growth to productivity, maintaining consumer demand, and preventing unemployment and other forms of privation.

Notably, austerity today often goes hand-in-hand with calls for labor market deregulation.


StevenAttewell 11.23.11 at 12:36 am

Kevin –

“Classical economists did acknowledge the value of “public works” as a palliative for unemployment.”

Yes and no. Classical economists at the same time espoused the absolute necessity for said public works to be self-liquidating, to not violate the balanced budget or sound money, and to in general be run as business-like as possible; they often reacted to actual calls for mass public works (as opposed to theoretical public works) with alarm about taxation/inflation/business confidence, fears of corruption and inefficiency, etc. This tended to undo any of the good their putative support might have done.

Hence why the Public Works Administration failed where the Civil Works Administration and the Works Progress Administration succeeded.


Jasiek aka Jan 11.23.11 at 2:48 am

Quote: “By contrast, under conditions of high unemployment, austerity measures reduce aggregate demand, and lead to further waste of resources through unemployment.

This should instead be: “By contrast, under conditions of high unemployment, if austerity measures reduce aggregate demand, it leads to further waste of resources through unemployment.

I doubt that austerity measures would always reduce aggregate demand even under conditions of high unemployment.

If austerity is ruthless enough to shift the schedule of marginal efficiency of capital downwards and the market rate of interest upwards, it would certainly reduce aggregate demand indeed. However, if the quality side of capital is changed as well as the quantity side, there could be a point with austerity at which the marginal efficiency of capital shift upwards thanks to a change in prospective yield of assets at home over the whole life with public investment projects, by a rearrangement of the remaining budget, like geographical restructuring committed to quality of capital (e.g. projects against urban sprawl as the Dutch did to escape from what you call the Dutch Disease), which also entails the difference between private capital and public capital deeply related to The Treasury View, and the market interest rates downwards thanks to a credit-positive change in market-confidence by which financial markets immediately purchase public debts more eagerly than otherwise thus aggregate demand increases. Hence, I think that mild austerity may be legitimate on the premise that the authority is committed to improving the quality side of capital even though without the state of full employment.

The quality side of capital is deeply related to real capital. As Joan Robinson explained in a famous argument with Paul Samuelson, real capital is not measurable. Thus, this issue is not sufficiently suitable for mathematical equilibrium-analysis approach. The policy-making with reference to quality of capital or real capital must require historical and sociological approaches, and I find both institutional change and public investment against urban sprawl worth a consideration in this regard. This is a matter of dynamic disequilibrium in a nutshell.

The above policy may additionally require some institutional change against induction of liquidity preference to shift the credit creation from speculation to enterprise. For one thing, financial transaction tax; for another thing, steepening the schedule of progressive taxation on the effective basis for the government to reduce the propensity to save, the increase of which has been aggravating speculation, and use much of the absorbed disposable income for the above public investment projects.

Professor, I think you’d better additionally say that The Treasury View requires the state of perfect competition, for the view is a reproduction of the orthodox argument that the optimal allocation of capital in view of not only the respective economic entities such as companies and households but also the society as a whole will be materialised when resources are reallocated through the perfectly competitive market. The argument requires institutional reform to make the real world a highly efficient market as a whole and thus the efficient-market hypothesis. Considering various fixed factors as part of the elements that constitute long-term expectations, it is obvious that the real world is not as malleable as the orthodox view expects. Hence, efficient-market hypothesis is utterly defective, and thus The Treasury View is unrealistic.

The fear on the authority’s side, which you mention in the last paragraph, may be a fear of the dynamics of disequilibrium which is not apt for mathematical equilibrium analysis. Government officials, by nature, need to present a meticulous reasoning on each policy they make even though they understand the notion of dynamic disequilibrium, such that it must be only politicians who hold the notion of dynamic disequilibrium in the context of The General Theory that can possibly make a breakthrough. On the contrary, if the policymakers hold other ideas, it is a disaster. And, I will be reading news from the United States and Germany from now.


reason 11.23.11 at 9:48 am

I think if we are talking about the post WWII period some notes about the special circumstances and their effect on the neo-Keynesian synthesis are worth making.

1. In world war II and the aftermarth, there was a lot of forced saving and so household balance sheets were very healthy.
2. Because the economy had concentrated on war production, and not production for private consumption there was indeed a lot of “pent-up” demand. This meant that in the immediate post war period the potential growth rate of many private was high.
3. Protectionism?

I would interpret these facts as having some implications for policies in the current circumstances where there is also a lack of aggregate demand but none of 1,2, or 3.


reason 11.23.11 at 9:52 am

In point 2 missed word – … the potential growth rate of many private INDUSTRIES was high.


reason 11.23.11 at 9:53 am

P.S. Like Kalecki (somewhere recently must find the link), I think we need a real helicopter drop (not parking the helicopter on Wall Street).


reason 11.23.11 at 9:59 am

Sorry of course it wasn’t Kalecki it was somebody referencing Kelecki – must find the link.


Tim Worstall 11.23.11 at 9:59 am

A purely personal foible but the economic history of the UK in 1925-1935 should make mention of the return to the gold standard (in Churchill’s most insane decision) at the pre-war rate and then how quickly things recovered after its abandonment.

Not exactly difficult to get that into a Keynesian framework …..

The value of making the point should be obvious when trying to explain current events in the eurozone……


reason 11.23.11 at 11:25 am

Ah, I see my error, it is Skidelsky not Kalecki – referenced from here:


Tim Wilkinson 11.23.11 at 11:29 am

gordon: I don’t remember seeing a Govt. bank seriously suggested since the dark days of late 2008/early 2009. Except in comments here on CT, of course.

UnlearningEcon: ‘guess’ was to be taken literally. I don’t want to derail either.

JQ: I’m still not seeing a specifically expansionary austerity claim – only the claim that austerity is not contractionary; or (equivalently?) that deficit/neutral spending is not expansionary (compared to the austerity baseline). I suppose the expression “(typically more productive)” might do it, but I’d have expected something more prominent and more categorical.

Also, for this lay reader, what the Treasury View is is a bit unclear. There’s the restatement of Say’s Law in terms of ‘crowding out’, but also the idea that sustained unemployment could only arise as a result of problems specific to labor markets, and the more general classical model of macroeconomics. The last of these seems to be identified with ‘the Treasury view’, in which case I’d suppose the other two subsumed by it, but it doesn’t sound right that the Treasury View should be equated with the whole of ‘classical macroeconomics’.

Then again, we have According to Say’s Law, unemployment can never arise through a deficiency in demand which suggests a closer link between the first two… anyway, I am a bit confused, fwiw.


Alex 11.23.11 at 11:50 am

Apparently, round about 1929, Winston Churchill had dinner with Charlie Chaplin, who spent the meal berating him about economics and specifically about how wrong he’d been about the return to gold. Churchill took the huff and didn’t cheer up until Chaplin told him a joke.

Liaquat Ahmed’s Lords of Finance has a very good chapter on the 1925 decision. WSC apparently decided to write up a long memo for the Cabinet arguing out the issues, which was a method he often used to understand new issues. He had the civil service send him a pile of data and briefing material, which may have been the genesis of the Treasury view. He seems to have come away very unconvinced – in Keynes’ telling, Reginald McKenna advised him that it wasn’t a good idea but would be unavoidable *politically* – presumably because the Treasury and BoE staff and the City wouldn’t let it rest?


Alex 11.23.11 at 11:53 am

Churchill played up the fact he hadn’t worked in an economic department or had much contact with economic policy, but you would think the Ministry of Munitions in 1916-1918 would have had quite a lot of macro-economic content, especially as one of its biggest problems was trying to manage the war economy’s demand for basically everything with regard to US dollar liquidity and UK inflation, or to put it another way, proto-Keynesian demand management.


Peter K. 11.23.11 at 5:47 pm


Watson Ladd 11.23.11 at 6:58 pm

You might also want to add on some things about the naturally anti-cyclic effect of benefits to the poor and how austerity prevents smoothing over the economic cycle. The benefits being cut in Britain today are not new ones: they are old ones that have suddenly grown more expensive.


Tim Wilkinson 11.23.11 at 9:16 pm

ffs Myles, it’s nothing to do with ‘suddenly growing more expensive’, and child benefit, housing benefit, Legal Aid to name a few hadn’t suddenly grown notably more expensive when cut. (And there is a variety of additional – or even ulterior – reasons unrelated to cost why cutting each of these was attractive to the Cons.)

You need to learn the difference between 1. what happens to pop into your head and sounds vaguely plausible to you for a moment, and 2. facts.


Tim Wilkinson 11.23.11 at 9:16 pm

Sorry – Watson, I mean.

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