In a recent paper in the Cambridge Journal of Economics, Daniel Kuehn storms into the face of austerity hawks by arguing that the 1920-21 recession – heralded by many as a poster-boy for austerity measures – is not applicable.
Strangely, even if I am an austerity hawk, I agree with his view. In short, Kuehn that the recession of 1920-21 was the result of a contraction in the aggregate supply caused by a series of strike and the reallocation of ressources following the end of the Great War which was hampered by numerous regulatory and fiscal controls.
Kuehn is right that it was indeed an issue linked with liberating aggregate supply from the chains that held it back. Indeed, Nicholas Crafts and Kent Matthews, in their respective studies of the Great Depression in the United Kingdom, found that it was the ability of the supply side to adapt rapidly (mainly in housing construction) which allowed the country to exit the recession earlier than the United States.
However, when he claims that austerity measures probably had no effect in the short run, they surely had an effect in the long run. The fiscal consolidation that began under Harding and continued under Coolidge sent a strong signal to financial markets about the commitment of the government with regards to its huge debt obligations and the fiscal environment it would create to repay them. In the long run, the austerity measures allowed to liberate resources in the private economy and reduce tax rates. In turn, this allowed the economy to grow even more.
In short, as I have argued elsewhere (albeit in French), austerity measures are not a driver, they are complements to supply side liberalization in order to sustain long term growth. Rather than arguing about austerity measures, we should argue about where to cut first in complement with liberalization policy.