Posts Tagged ‘Keynesian economics’

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It’s a bit odd isn’t it? How can you reduce debt by spending more? That great raconteur of our times George Osborne likes to point out the evident ridiculousness of such an idea. With that cheeky grin of his, he says: “I don’t believe you can cut debt by spending more.”

And yet, despite the silliness of the very suggestion, UK debt is not falling. It is not like that in the US, however, where the government has been far more Keynesian in its approach.

The US deficit this year is expected to be $642 billion, or so estimates the Congressional Budget Office. To put that in context, last year the deficit was $1.1 trillion. It will, in fact, be the first time since 2008 that the US deficit is less than $1 trillion. And, by the way, not so long ago the Congressional Budget Office was projecting a deficit of almost $200 billion more than that.

Looking forward, the deficit is expected to fall even further, dropping to $378 billion in 2015.

The good news does not stop there, however. US household debt has fallen from $12.7 trillion in 2008, to $11.2 trillion at the end of last year. In fact, according to IMF data, US household debt to income has fallen from a ratio of 1.3 in the mid-noughties to around 1.05. In fact, the ratio is now higher in the Eurozone.

Back to the public deficit, and two main factors explain the fall. The expiry of George Dubya Bush’s payroll tax credit means more income is coming in. Recovering US housing prices mean the US government expects a windfall from Fannie Mae and Freddie Mac.

You would expect cheers over the news in the US, wouldn’t you? Well no doubt Mr Obama is cheering, but oddly economists and politicians on the left and right are fretting.

On the right they don’t like it. They fear that they are losing the moral high ground. How can they demand tax and spending cuts to get debt under control when it is falling so fast anyway? The truth is that the arch Austerians have a philosophical problem with any form of government spending except on perhaps on law, order and defence. They want to see cuts, whatever is happening to debt.

On the left, they don’t like it because they think the US needs more government spending; it needs more Keynesian policies, and the fact that debt is falling is symptomatic of a lack of government stimulus.

In the longer term two problems remain.

By the mid-2020s government debt is expected to rise again as the baby boomer generation retires – this problem can be overcome, however, by raising the retirement age.

A more serious challenge may relate to the burgeoning level of student debt. Nobel Laureate Joseph Stligtz reckons this is the next debt crisis in waiting. See: Student Debt and the Crushing of the American Dream

© Investment & Business News 2013

“We are all Keynesians now,” or so said Milton Friedman in 1965. Later, President Nixon said: “I am now a Keynesian in economics”, and popular misconception has thrown up the view that it was Nixon who made the comment about us all being Keynesian.

Political leaders in South America could say it now, too. Leaders across the continent would sound eminently consistent if they too said: “We are all Keynesians now.” It is just that they aren’t and neither was Nixon, and neither was Friedman. Keynes advocated a certain set of policies under certain conditions: namely when monetary policy no longer worked no matter how low interest rates were, and when people still weren’t spending. He called the use of monetary policy in such times pushing on string.

Others call it liquidity trap conditions.

Right now in South America, monetary policy is not pushing on string, and there is no liquidity trap. Ditto the US economy in the 1960s. The policies that were adopted in the 1960s and to a lesser extent in South America today may be called Keynesian by some, but it is doubtful that Keynes would have called them that.

Keynes would have called for the remedies he famously advocated only when interest rates had fallen so low, that they cannot fall any lower. That is to say, about now in the US, the UK, Europe and Japan, but not in South America.

If you are running late and stuck in traffic, hitting the gas won’t help. But if you are running late, and the motorway is empty, and devoid of speed cameras, then upping your speed will help you to complete the journey quicker. Critics of Keynes who said his ideas didn’t work in the 1960s and thus won’t work now, are like someone who concludes, after a day spent in heavy traffic, that there is never any advantage in driving over 30 miles per hour.

© Investment & Business News 2013