We are all Keynesians (again)
In 1968 Time Magazine — back when it was the most relevant news periodical - put John Maynard Keynes on the cover declaring “We Are All Keynesians Now.” And in 1971 when abandoning the gold standard and implementing price controls against his economic dogma, Richard Nixon effectively put it into practice as national policy.
To grossly simplify, Keynesian economics postulates that the government can play a constructive economic role by acting as a counter-cyclical actor in cushioning the effects of the economic cycle by offsetting the economic effects of the private sector through fiscal policy. His implications were profound and have since been hotly debated, particularly on the right and in Europe as there are many who believe that government should maintain balanced budgets and maintain fiscal austerity in difficult economic times. Keynes made the provocative argument (at the time) that the Great Depression was caused by the onerous and punitive economic sanctions placed on Germany and exacerbated by the policy response. And within the United States, the implication that the Hoover administration’s response turned a recession into depression became deeply partisan issue that has largely defined the left/right divide since. That the Roosevelt administration then created the New Deal, creating the Federal Reserve system and both a temporary and permanent welfare state left many on the right fighting to roll back for generations.
Following Nixon’s bold pronouncement an against the conservative critique, the Regan revolution, supported by Milton Friedman & other conservative thinkers successfully swept away Keynesian economics, even under the Clinton administration when additional cuts to welfare and other social programs were made.
This thinking changed temporarily from 2007 - 2009 but we may recall required multiple failed votes through congress to get stimulus and TARP passed with years of divisive recrimination to follow. Though the Great Recession caused some economies to hold their nose and offset the economic downfall with fiscal stimulus, most economists would argue that the action in the United States was merely enough to hold off Depression and did little to hold back economic growth. In Europe, the lack of coordinated fiscal stimulus kept the continent in economic malaise that largely continued until the COVID-19 crisis.
And yet, as a result of COVID-19, Keynesianism is back baby! Global stimulus has been swift, large (save for perhaps China) and relatively popular, global interest rates have been lowered dramatically to zero in many cases, quantitative easy is back in force never seen before as certain asset classes have been nationalized by Fed purchases & coordinated swaps to global central banks. We’ve even nationalized junk bonds! Clearly the response of the financial markets & the dialogue suggests that there is broad appeal to the notion that fiscal & monetary policy can be constructive in staving off the worst of economic calamity to an extent that has not been observed since the 1970’s. Certainly having an external shock to fight, whether global pandemic or foreign attack can help forge consensus.
But is Keynesianism truly back for good? Probably not and even if in vogue now, it’s hard to imagine this consensus continuing for very long. As fiscal conservatives would note, at least in the United States, we have run significant deficits since the 1990’s when we ran a fiscal surplus due to the accident of an unexpected booming economy and tight-fisted Republic congress that did not want to support a somewhat fiscally-conservative Clinton administration with support for their spending desires. Since then, fiscal discipline gave way first with the Bush tax cuts, wars in Afghanistan & Iraq before the Great Recession. As the Obama administration exited offer with a narrowing deficit, the Republican tax cuts in 2017 generally repeated the fiscal action of Bush in 2001 with similarly tepid results.
The problem with Keynesianism and why so many reject it on both sides of the aisle is that it requires that policy makers use it through the entirety of the economic cycle, not just during economic declines, and use fiscal policy, not just central-bank policy as a brake to fiscal expansion. This means raising taxes, cutting spending, paying down debt and putting aside reserves when the government can afford to do so. This will moderate economic growth and perhaps stave off over-balances which can in turn cause recession. And any of these actions would be considered political suicide.
For the last 20 years, somehow (and largely supported by the Fed and willing buyers of US debt) policy markers — with exception of the Obama administration who was hemmed in by the Republican congress — have escaped making the hard decisions and it’s worked, despite warnings that long-term interest rates could rise. But I question whether it will last forever and that there will be a day when we can’t simply print infinite money, long-term rates will raise and have to pay the piper in the form of draconian fiscal measures. It’s not a terrorist attack or a public health crisis which directly kills many but the general loss of confidence in the US debt and inability to finance at normal levels, a sovereign debt crisis is not unprecedented. It’s happened in just about every other country of the world and there’s no reason why it can’t happen here. If I were Treasury Secretary, it’s what would probably keep me up most at night.