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Austerity is working

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Fred Prouser/Reuters

(Read caption) A worker is pictured at a residential construction project along N. Beverly Glen Boulevard, a two lane road in Los Angeles, California February 3, 2012. Construction spending is at its highest in four months.

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With both the manufacturing and the non-manufacturing surveys indicating increased expansion and with construction spending and employment increasing, it seems clear that the U.S. economy has started to go from the ""recovery" that feels like a continued recession for most people" state it has been in since the summer of 2009 to something resembling a real recovery, though still nowhere near as vigorous as for example the 1983-84 recovery.

What are the causes of this turnaround? In part it reflects the fact that growth is the natural state of the economy and that the factors that depressed it are dissipating and in part it reflects a credit-driven investment boom. Fixed business investments rose 7.5% in real terms in the year to the fourth quarter financed by a 11.4% gain in commercial & industrial loans. The fact that it is credit-driven indicates that it is an early stage of a classical Austrian business cycle scenario, but with the level of investments still below the peak levels of previous expansions, there is room for further expansion.

One aspect that makes the upswing look sounder is that it has happened while government spending has declined. The category government purchases (spending excluding transfer- and interest payments) has dropped from a post-1992 peak of 21.1% of GDP in the third quarter of 2009 to 19.7% in the fourth quarter of 2011, mostly because of spending cuts at the state and local levels.

This makes what Krugman wrote a few months ago especially interesting:

"Basically, government has been shrinking for the past year — in practice, fiscal policy has been doing exactly what Republicans say it should be doing. Where’s my confidence fairy?"

Right here, it seems.


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