By Scott Sumner
David Henderson has a very good post on the Canadian economy. David argues that austerity can be expansionary, and points to the example of Canada in the 1990s. Josh Barro counters that Canada was aided by an expansionary monetary policy:
Canada’s 1990s austerity was able to be expansionary because of an export boom that coincided with government spending cuts. The boom owed something to the North American Free Trade Agreement, which fits the conservative narrative. But a weak currency also favored exporters. In January 1995, the Canadian dollar stood at $0.71, down from $0.89 in November 1991, which prompted The Journal to mock the currency as the “northern peso.” But even as Canada’s broad economic metrics improved through the 1990s, the currency kept falling, hitting $0.65 in August 1998. Conservatives urging the United States to follow Canada’s fiscal example usually leave out the “weaken your currency” part of the plan.
That’s a good criticism of some conservatives. But Paul Krugman praises Barro’s argument, even though it indirectly discredits Krugman’s claims. Recall that Krugman argued that expansionary austerity won’t work at the zero bound, because monetary policy cannot offset fiscal austerity. And that means, ipso facto, that monetary policy cannot depreciate currencies at the zero bound. But in the time since Krugman made that argument both Switzerland and Japan have done exactly that, using expansionary monetary policy to depreciate their currencies at the zero bound. This shows that Krugman is wrong about monetary policy, and hence wrong about expansionary austerity. The Canadian experience of the 1990s is very relevant to the problems faced by Europe, Britain and Japan at the zero bound.
Barro also points out that both Canada and Australia have benefited from strong commodity markets in recent years. That’s true, but it’s a two-edged sword. Because commodity markets are far more volatile than other sectors, countries that rely on commodities will tend to have a more unstable business cycle than those that don’t. And yet both Australia and Canada have recently had a more stable business cycle than the US. Indeed Australia hasn’t had a recession since 1991, even avoiding recession in years when commodity prices were low. That’s because they’ve had better monetary policy.
Paul Krugman takes David Henderson to task for making false claims about government spending in Canada:
When dealing with right-wing claims about economic data, you should never forget Moore’s Law: not only shouldn’t you accept their assertions, you should assume that what they say is probably wrong. Barro:
Squeezed by high interest rates, a left-of-center government instituted big spending cuts in the 1990s; as a result, Canada’s level of public expenditure as a share of its economy has fallen to match America’s.
From the IMF database:
And indeed the IMF data shows that government spending in Canada is more than 6 percentage points higher (as a share of GDP) than in the US. This surprised me, as I recall the two being quite similar. And other data sources like Wikipedia show them to be similar. Then I checked an earlier link to the IMF, from their October 2012 data set, just 18 months before the one cited by Krugman. Sure enough, the Government spending/GDP ratios for the US and Canada were only 1.2% apart in 2011. So why has the gap suddenly widened? It hasn’t, the IMF data set cited by Krugman shows the gap to be 5.75% back in 2011. Indeed the figures also differ sharply for 2010, and earlier years. It seems the IMF has great trouble determining the actual ratio of government spending to GDP. It would be nice if there were an international organization that could produce reliable figures; does anyone know of one?