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Are We All Keynesians Now?

Omkar Goswami

Given the sheer brilliance of John Maynard Keynes, it is not surprising that the term ‘Keynesian’ is omniscient. Today, as governments led by the USA pump hundreds of billions of dollars to save the global financial system from total collapse, commentators are speaking of the shift in policy from supply-side economics to Keynesian demand and liquidity management.

The present financial intervention may be the greatest in global economic history. If you add to the US Treasury’s bailout the lifelines thrown by the UK, the European Central Bank, Switzerland, India and other nations, we are looking at a kitty of over $1.75 trillion that is already committed to injecting liquidity and saving banks and financial institutions from correlated collapse.

Is this the return of Keynesian economics? In some sense it is.

Nothing fuels demand more than liquidity. Equally, nothing contracts demand more than the lack of it. The US, UK and Europe were seeing a growth slowdown before this financial crisis. From early 2007, household spends were not rising fast enough; manufacturing and retail sales growth were declining; and aggregate demand was under pressure. With a 25 per cent fall in home prices from January 2006 to December 2007, there were serious uncertainties in the US. The UK, Italy, France and Spain were not far behind. The growth engine had, therefore, seriously started sputtering by the end of 2007.

What has happened since, especially from the second half of 2008, is a rapid breakdown of public confidence thanks to the failure of one major financial institution after the other. It has gummed up all the liquidity in the world and, with it, put the brakes on aggregate demand. Any institution that is lucky to have cash will not spend it. Forget about borrowing. Forget about spending. Forget about lending. Forget about entrepreneurial animal spirits. Forget about growth. Just pray to survive. It is as if we were in the middle ages and the plague had hit the next village.

Had this continued without any state intervention, the global financial system would have already collapsed. The huge intervention is Keynesian in the sense that it is trying to pump the stuff that makes transactions happen — and thus induce greater demand leading to greater supply. It isn’t real investment in the traditional Keynesian sense. But it is autonomous financial injection with the hope that it will restore confidence and bring with it a milieu that can fund real investments, create demand and hence, growth.

Will it be the beginning of a long era of government sponsored pump priming as we saw from the 1960s to the early 1980s? I think not. Crude Keynesian economics encourages fiscal profligacy and state spending on consumption rather than investment. It also bestows extraordinary powers on bureaucrats — people who are least equipped to handle such challenges. Every sensible government today, including India, believes more in the positive powers of fiscal rectitude than ever before. Besides, supply-side economics has taught us that, in most cases, with correct incentive structures the markets do the right things.

So, I see this as a massive one-shot Keynesian intervention for a Black Swan event. It is absolutely essential and needs even greater global coordination. But I don’t see this as the beginning of widespread fiscal profligacy in the name of Keynes. He doesn’t deserve such opprobrium.


Published: Business Today, November 2008


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