Keynesianism Might Help Tackle The Gathering Economic Crisis – OpEd

By Jonathan Power*

The most peculiar aspect of the gathering economic crisis so far is that no one has mentioned the three words, John Maynard Keynes.

Keynesian economics, intellectually derided by the Chicago school, in particular Milton Friedman, and politically rubbished by Margaret Thatcher and Ronald Reagan, had one of its periodic comebacks following the crash of 2008. “Signs of solution are at last beginning to emerge where it matters most,”, editorialized the Financial Times, “the use of public funds to support the banking system and a readiness to put fiscal policy on an expansionary track”. That was very Keynesian.

Yet, even now, sizable elements of anti-Keynesianism persist despite the serious current economic malaise. There is talk of a global recession. The US Federal Reserve is probably going to raise interest rates by 1 point. The UK Conservative government has a long record of cutting social expenditures in order to run a surplus, which Conservatives continue to be for. Yet many high-powered academics have proved that raising interest rates and cost-cutting on expenditures of any kind- social or otherwise—will hit the less fortunate most.

These, important errors though they be, are minor flaws compared with the refusal to open the door to a wider intellectual appreciation of Keynesian teaching on the need for greater liquidity resources from governments or from the International Monetary Fund (IMF).

Keynes believed that if the IMF or individual high-income countries such as the US and UK used the resources they have then growth need not be hampered, despite an apparent crisis. What the US and UK have right now is not so much an impending economic crisis as a liquidity crisis.

Just before the end of the Second World War, the Western powers decided to rethink the international financial system. Meeting in July 1944 at Bretton Woods their top experts, including Keynes, discussed a new world order, convinced that the global system could not be left to the mercy of unilateral action by governments or to the unregulated workings of the international markets. Thus emerged the IMF and the World Bank. It was at the the same time a great achievement and a great disappointment. Over the last eight decades, both institutions have been invaluable, but this success only begs the question what might they have done if Keynes’ original vision had not been cut down in size.

Keynes proposed an IMF whose resources would be equal to one-half of world imports. Keynes saw the IMF evolving into a world central bank able to issue its own reserve currency sufficient to meet the needs for expansion whenever and wherever needed. Today, the IMF does have so-called Special Drawing Rights, but they amount to only a small fraction of world liquidity.

Keynes regarded balance of payments surpluses as a vice and deficits as a virtue. It is deficits that sustain demand and generate increased employment. He went so far as to argue that outstanding trade surpluses should be penalised by an interest rate of 1% a month. Thus, in Keynes’ vision, there would be no persistent debt problems as surpluses would be used by the IMF to finance deficits. Keynes’s vision has never been realised.

“So what happens now if interest rates increase?” asked the Nobel Prize-winning economist Paul Krugman recently, “No one knows. If you want to be optimistic, you might argue that there is no need to panic since spiralling debt is a feature of an increasingly sophisticated globally integrated world, not a bug.”

Let’s take this optimistic scenario:

Right now, the European Union is actually implementing a policy that should help bring down interest rates—giving free 390 billion euros and a further 360 billion euros in low-interest loans (about the same in US dollars) to the southern European countries as they battle the economic and financial fall-out from the coronavirus, just when they were recovering- some very slowly- from the economic disaster brought on by the American-led crash of 2008.

At first, the big hitters in the EU, Germany and France, said the money wasn’t there (partly because they thought it would be inflationary). But quite quickly, they changed their mind and said it was, and it could be given, not even lent.

Where did the northerners get such large amounts of money from? From their own overdraft. They used as collateral their heavyweight economies, enabling them to borrow at very low-interest rates.

Could they do the same today when interest rates are going up? They could because, by historical standards, interest rates and inflation are projected to fall next year as the slow down on the supply side of the world economy eases as the impact of the Corona-induced setback continues to lessen. Moreover, it seems Russia is going to loosen its grip on Ukrainian grain exports. So inflation and thus interest rates should come down, if not to nearly zero as they have been with the US Federal Reserve and the European Central Bank, at least to 2% or 3%, which is very small compared with the earlier pre-2008 decade. According to last week’s Economist, the UK treasury today can still borrow for 10 years at an annual interest rate of just 2.1%.

In the UK contest for a new prime minister, the former chancellor of the exchequer (minister of finance) Rishi Sunak, is arguing that he would implement a tax rise if made the country’s boss.

This is both anti-Keynesian and short-sighted. The poorer parts of British society have already been badly squeezed by 12 years of Conservative rule. Child poverty has increased badly, libraries have been shuttered, and the free health service short-changed. Most likely, more tax rises will be loaded against the poor, while giving the well-to-do a relatively lesser burden. This is the reverse of what should happen.

Keynes is widely regarded in the economics profession as the wisest economist who ever lived, save for Adam Smith, the originator of the science in the eighteenth century. To summarise, Keynes said in effect, “Let’s look at the problem this way. In a recession, a family has to cut its budget to survive. But, paradoxically, if a nation is in a recession, the government must spend if it is to get the economy and thus the national income per head to rise. Even though it will run a deficit and increase its debt if it’s growing it will outrun the new debt. As long as its economy is strong and well-managed it is more than credit-worthy and can carry the debt”.

To deal with the crisis of 2008, American policy under the government of President Barack Obama became practically 100% Keynesian. The Federal Reserve immediately after his election pumped $85 billion into the economy. When asked if the Fed had that amount of money on hand, its chairman Bernard Bernanke said, “we have 800 billion”. In fact, it had more—an unlimited credit card. The Fed can just print money, as many dollars as it wants. So too can the ECB and Japan. By the end of 2008, the Fed had pumped 1.3 trillion into the economy. Later, even conservative Germany went along with this policy.

The coronavirus made the policy relevant again in the US too, even more so than in 2008. The chair of the Fed, Jerome Powell, said, “when it comes to lending, we are not going to run out of ammunition”.

The policymakers today should be as wise as Keynes. Now is the time for governments to raise their spending, especially social and climate spending. They can afford to because it will precipitate growth. Growth will enable interest rates to fall. In this case, lower interest rates and growth will help lower the inflation rate. We should keep our eyes focussed on the Keynesian mantra.

The writer is the author of “Development Economics” (Pearson Longmans). For 17 years he was a foreign affairs columnist for the International Herald Tribune. See his website for more information: jonathanpowerjournalist.com