The Other Kind of Austerity… Low labor share
Austerity by governments is a policy to reduce budget deficits by cutting spending and/or raising taxes. Basically governments withhold money from the economy. The result is that aggregate demand is reduced.
Yet, there is another form of austerity where businesses lower pay to labor. In effect, businesses withhold money from the economy by reducing pay to labor. In England, real wages are falling. Labor is less able to spend money. In the US, labor share has fallen over 6% since the crisis.
It is good that economists like Paul Krugman harp on government austerity policies. It is even better when they also harp on the austerity from businesses keeping labor’s wages low.
To say that lower labor share does not lower potential output shows a lack of understanding the economy.