Politicians Ignore Keynes at Their Peril
by Dean Baker
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 is the co-director of the Center for Economic and Policy