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Politicians Ignore Keynes at Their Peril
May 18, 2010
John Maynard Keynes explained the dynamics of an economy in a prolonged period of high unemployment more than 70 years ago in The General Theory.
Unfortunately, it seems very few people in policymaking positions in
the United States or Europe have heard of the book. Otherwise, they
would be pushing economic policy in the exact opposite direction than
it is currently heading.
Most wealthy countries have now
made deficit reduction the primary focus of their economic policy. Even
though the US and many eurozone countries are projected to be flirting
with double-digit unemployment for years to come, their governments will be focused on cutting deficits rather than boosting the economy and creating jobs.
The outcome of this story is not pretty.
Cutting deficits means raising taxes and/or cutting spending. In either
case, it means pulling money out of the economy at a time when it is
already well below full employment. This can lower deficits, but it
also means lower GDP and higher unemployment.
This might
be OK if we could show some benefit from lower deficits, but this is a
case of pain with no gain. Ostensibly, there will be a lower
interest-rate burden in future years, but even this is questionable.
First, the contractionary policy being pursued by the deficit hawks
will slow growth and lead to lower inflation or possibly even
deflation. It is entirely possible that the debt-to-GDP ratio may
actually end up higher by following their policies than by pursuing
more expansionary policy.
In other words, we may end up
with smaller deficits and therefore accumulate less debt, but we may
slow GDP growth even more. The burden of the debt depends on the size
of the economy and in the scenario where we do more to slow GDP growth
than the growth of the debt, then we end up with a higher interest-rate
burden, not a lower one.
The other reason why we may not
end up with a lower interest rate-burden is that we need not issue debt
to finance the budget deficits. Countries such as the United States and
the United Kingdom that control their central banks can simply have the
central banks buy up the bonds used to finance the deficits. In this
story, the interest payments on the bonds are paid to the central bank,
which is in turn refunded to the government. This means that there is
no interest-burden created by these deficits.
If that
sounds impossible, then it's necessary to pick up Keynes again. The
economies of Europe and the United States are not suffering from
scarcity right now. They are suffering from inadequate demand. This
means that if governments run deficits, and thereby expand demand, the
economy has the capacity to fill this demand. The decision of central
banks to expand the money supply by buying bonds simply leads to an
increase in output, not to inflation.
The idea that there
is a direct link between the money supply and inflation is absurd. Do
any businesses raise their prices because the Fed has put money into
circulation? How many businesses even have a clue as to how much money
is in circulation? In the real world, prices are set by supply and
demand. If any businesses tried to raise their prices just because the
Fed has put more money into circulation they would soon find themselves
wiped out by the competition - at least as long as we are in this
situation of having enormous excess supply.
This story
should be old hat to those who have studied Keynes. In a period of high
unemployment, like the present, governments can literally just print
money. Not only will this put people back to work, this process can
also lay the basis for stronger growth in the future by creating better
infrastructure, more energy-efficient buildings, supporting research
and development of clean energy and improving the education of our
children.
Unfortunately, our political leaders don't give
a damn about mundane issues such as unemployment and economic growth.
It is far easier for them to bandy about silly cliches about fiscal
responsibility and generational equity, even though the policies they
are pushing are 180 degrees at odds with anything that will help our
children or grandchildren. Their main concern is pushing policies that
keep the financial industry happy. And 10 million unemployed never
bothered anyone at Goldman Sachs, just as Fabulous Fabio.
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Dean Baker
Dean Baker is the co-founder and the senior economist of the Center for Economic and Policy Research (CEPR). He is the author of several books, including "Getting Back to Full Employment: A Better bargain for Working People," "The End of Loser Liberalism: Making Markets Progressive," "The United States Since 1980," "Social Security: The Phony Crisis" (with Mark Weisbrot), and "The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer." He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues.
John Maynard Keynes explained the dynamics of an economy in a prolonged period of high unemployment more than 70 years ago in The General Theory.
Unfortunately, it seems very few people in policymaking positions in
the United States or Europe have heard of the book. Otherwise, they
would be pushing economic policy in the exact opposite direction than
it is currently heading.
Most wealthy countries have now
made deficit reduction the primary focus of their economic policy. Even
though the US and many eurozone countries are projected to be flirting
with double-digit unemployment for years to come, their governments will be focused on cutting deficits rather than boosting the economy and creating jobs.
The outcome of this story is not pretty.
Cutting deficits means raising taxes and/or cutting spending. In either
case, it means pulling money out of the economy at a time when it is
already well below full employment. This can lower deficits, but it
also means lower GDP and higher unemployment.
This might
be OK if we could show some benefit from lower deficits, but this is a
case of pain with no gain. Ostensibly, there will be a lower
interest-rate burden in future years, but even this is questionable.
First, the contractionary policy being pursued by the deficit hawks
will slow growth and lead to lower inflation or possibly even
deflation. It is entirely possible that the debt-to-GDP ratio may
actually end up higher by following their policies than by pursuing
more expansionary policy.
In other words, we may end up
with smaller deficits and therefore accumulate less debt, but we may
slow GDP growth even more. The burden of the debt depends on the size
of the economy and in the scenario where we do more to slow GDP growth
than the growth of the debt, then we end up with a higher interest-rate
burden, not a lower one.
The other reason why we may not
end up with a lower interest rate-burden is that we need not issue debt
to finance the budget deficits. Countries such as the United States and
the United Kingdom that control their central banks can simply have the
central banks buy up the bonds used to finance the deficits. In this
story, the interest payments on the bonds are paid to the central bank,
which is in turn refunded to the government. This means that there is
no interest-burden created by these deficits.
If that
sounds impossible, then it's necessary to pick up Keynes again. The
economies of Europe and the United States are not suffering from
scarcity right now. They are suffering from inadequate demand. This
means that if governments run deficits, and thereby expand demand, the
economy has the capacity to fill this demand. The decision of central
banks to expand the money supply by buying bonds simply leads to an
increase in output, not to inflation.
The idea that there
is a direct link between the money supply and inflation is absurd. Do
any businesses raise their prices because the Fed has put money into
circulation? How many businesses even have a clue as to how much money
is in circulation? In the real world, prices are set by supply and
demand. If any businesses tried to raise their prices just because the
Fed has put more money into circulation they would soon find themselves
wiped out by the competition - at least as long as we are in this
situation of having enormous excess supply.
This story
should be old hat to those who have studied Keynes. In a period of high
unemployment, like the present, governments can literally just print
money. Not only will this put people back to work, this process can
also lay the basis for stronger growth in the future by creating better
infrastructure, more energy-efficient buildings, supporting research
and development of clean energy and improving the education of our
children.
Unfortunately, our political leaders don't give
a damn about mundane issues such as unemployment and economic growth.
It is far easier for them to bandy about silly cliches about fiscal
responsibility and generational equity, even though the policies they
are pushing are 180 degrees at odds with anything that will help our
children or grandchildren. Their main concern is pushing policies that
keep the financial industry happy. And 10 million unemployed never
bothered anyone at Goldman Sachs, just as Fabulous Fabio.
Dean Baker
Dean Baker is the co-founder and the senior economist of the Center for Economic and Policy Research (CEPR). He is the author of several books, including "Getting Back to Full Employment: A Better bargain for Working People," "The End of Loser Liberalism: Making Markets Progressive," "The United States Since 1980," "Social Security: The Phony Crisis" (with Mark Weisbrot), and "The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer." He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues.
John Maynard Keynes explained the dynamics of an economy in a prolonged period of high unemployment more than 70 years ago in The General Theory.
Unfortunately, it seems very few people in policymaking positions in
the United States or Europe have heard of the book. Otherwise, they
would be pushing economic policy in the exact opposite direction than
it is currently heading.
Most wealthy countries have now
made deficit reduction the primary focus of their economic policy. Even
though the US and many eurozone countries are projected to be flirting
with double-digit unemployment for years to come, their governments will be focused on cutting deficits rather than boosting the economy and creating jobs.
The outcome of this story is not pretty.
Cutting deficits means raising taxes and/or cutting spending. In either
case, it means pulling money out of the economy at a time when it is
already well below full employment. This can lower deficits, but it
also means lower GDP and higher unemployment.
This might
be OK if we could show some benefit from lower deficits, but this is a
case of pain with no gain. Ostensibly, there will be a lower
interest-rate burden in future years, but even this is questionable.
First, the contractionary policy being pursued by the deficit hawks
will slow growth and lead to lower inflation or possibly even
deflation. It is entirely possible that the debt-to-GDP ratio may
actually end up higher by following their policies than by pursuing
more expansionary policy.
In other words, we may end up
with smaller deficits and therefore accumulate less debt, but we may
slow GDP growth even more. The burden of the debt depends on the size
of the economy and in the scenario where we do more to slow GDP growth
than the growth of the debt, then we end up with a higher interest-rate
burden, not a lower one.
The other reason why we may not
end up with a lower interest rate-burden is that we need not issue debt
to finance the budget deficits. Countries such as the United States and
the United Kingdom that control their central banks can simply have the
central banks buy up the bonds used to finance the deficits. In this
story, the interest payments on the bonds are paid to the central bank,
which is in turn refunded to the government. This means that there is
no interest-burden created by these deficits.
If that
sounds impossible, then it's necessary to pick up Keynes again. The
economies of Europe and the United States are not suffering from
scarcity right now. They are suffering from inadequate demand. This
means that if governments run deficits, and thereby expand demand, the
economy has the capacity to fill this demand. The decision of central
banks to expand the money supply by buying bonds simply leads to an
increase in output, not to inflation.
The idea that there
is a direct link between the money supply and inflation is absurd. Do
any businesses raise their prices because the Fed has put money into
circulation? How many businesses even have a clue as to how much money
is in circulation? In the real world, prices are set by supply and
demand. If any businesses tried to raise their prices just because the
Fed has put more money into circulation they would soon find themselves
wiped out by the competition - at least as long as we are in this
situation of having enormous excess supply.
This story
should be old hat to those who have studied Keynes. In a period of high
unemployment, like the present, governments can literally just print
money. Not only will this put people back to work, this process can
also lay the basis for stronger growth in the future by creating better
infrastructure, more energy-efficient buildings, supporting research
and development of clean energy and improving the education of our
children.
Unfortunately, our political leaders don't give
a damn about mundane issues such as unemployment and economic growth.
It is far easier for them to bandy about silly cliches about fiscal
responsibility and generational equity, even though the policies they
are pushing are 180 degrees at odds with anything that will help our
children or grandchildren. Their main concern is pushing policies that
keep the financial industry happy. And 10 million unemployed never
bothered anyone at Goldman Sachs, just as Fabulous Fabio.
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