Regular readers will be aware that on the topic of austerity, I generally agree with John Maynard Keynes:

The boom, not the slump, is the right time for austerity at the Treasury.

Regular readers will also know that I like Ron Paul — a Presidential candidate who promises a $1 trillion spending cut in his first year in office.

Is that a contradiction? I don’t think so.

Why?

In comparison to most austerity-stricken nations, the United States under Ron Paul would be a special case, for one key reason.

Ron Paul’s cuts — rather than destroying productive output like Brüning in the 1930s, or Papandreou today — are aimed at cutting the two greatest wastes of productive output: financial sector corporate welfare, and imperial military spending.

This topic cuts to the heart of the Keynesian and Rothbardian views on recessions in general, and depressions in particular.

Essentially, the Keynesian position (and its later monetarist adaptation) is that a slump in aggregate demand (i.e. GDP) is — for whatever reason — the problem, and that this can be remedied by the government doing whatever it can to raise aggregate demand (Keynesian stimulus, quantitative easing, nominal GDP targeting).

The Rothbardian position is that the problem is caused by government-led malinvestment, and that the junk must be allowed to liquidate before an organic recovery can ever take hold (zombification).

Both views have something to them, but both views overcomplicate the problem. The real issue is the drop in productive output.

As I have shown before, it is perfectly possible (and actually quite common) for monetary and fiscal policy to raise or stabilise aggregate demand without actually addressing the underlying productivity issue — leading to superficial (and hollow) recovery, like Japan in the 90s and (probably) America today.

Austerity policies during a recession can often totally choke off productivity (Brüning, Papandreou, etc). This is particularly true in nations that are very centralised, and where government has become a very important economic actor.

Now Austrian economists may say that government spending is always a misallocation of capital. Well, I agree that central planners lack the information of the free market. But government is useful in supporting underlying productivity (as Adam Smith noted) through infrastructure creation, the rule of law, etc, and withdrawing that support during a slump for the purpose of paying down debt is detrimental.

So the key here is that government should do what it can to support productivity. What the Keynesians (and monetarists) got wrong is the idea that aggregate demand was somehow a good reflection of underlying productivity, and that underlying productivity can be effectively supported with money pumping, or by digging holes. My model is that the best means to sustain and increase underlying productivity is that government should let failing economic systems completely fail, end wasteful and capital-destroying activities like imperial adventurism, and recapitalise the broader people of the nation. Ron Paul’s aim of cutting taxes and simultaneously cutting military adventurism and corporate welfare would do that.  His policies are not the austerity policies of tax hikes and spending cuts which constrict the economy by sucking money out to pay down creditors without putting anything back in.