History Lessons for Euro Debtors

When the financial crisis struck, there were widespread calls for new economic thinking; surely, many believed, the drastic events showed that there was something terribly flawed about economic analysis. In fact, however, the crisis itself, and even more the developments that followed, have been anything but puzzling. Again and again, things have played out pretty much the way you would have expected if you (a) understood and took seriously basic Hicks/Keynes macroeconomics and (b) paid attention to the relevant economic history.

The problem has been that all too many policymakers and pundits were and are either ignorant of these basics or determined to ignore them — or, putting these together, determined to be ignorant. Year after year, as we reproduce the 1930s, the usual suspects have been obsessed with fears of a return to the 1970s; as we become Japan they worry that we’re about to become Zimbabwe; and so on.

So, on the issue of the moment, there are actually quite good historical models for what Greece has been trying to do — cope with a large debt overhang via austerity policy. Britain, after all, emerged from each world war with very high public debt. Its debt burden just after World War I was, as a share of GDP, roughly comparable to Greece’s in 2009; its burden after World War II was twice as high.

What happened? Almost three years have passed since the IMF — yes, the IMF — pointed out that Britain between the wars tried a strategy much like that of European debtors: hard money plus austerity. Britain was incredibly determined, running huge primary surpluses as a share of GDP; but it failed to make a significant dent in the debt burden, because deflation ate up any gains from fiscal austerity: