Keynes was right!

This ‘must-read’ column is not gated. Click on the link below to download all 11 paragraphs. The language is clear, concise, easy to understand. IMHO, the analysis is spot on. If you disagree, please post a comment.

Countries that took emergency measures to reduce public borrowing have mostly suffered weaker growth, as in the case of Britain from 2010 to 2012, Japan this year and the United States after the 2013 “sequester” and fiscal cliff deal. In more extreme cases, such as Italy and Spain, fiscal tightening has plunged them back into deep recession and aggravated financial crises. Meanwhile countries that ignored their deficit problems, as in the United States for most of the post-crisis period, or where governments decided to downplay their fiscal tightening plans, as in Britain this year or Japan in 2013, have generally done better, both in terms of economics and finance. The one major exception has been Germany, where budgetary consolidation has managed to coexist with decent growth, largely because of a boom in machinery exports to Russia and China that is now over, pushing Germany back into the recession its stringent fiscal policy suggested all along.

Thus the six years since 2008 have provided strong empirical support for the supposedly outmoded Keynesian view that government borrowing is more powerful than monetary policy in stimulating severely depressed economies and pulling them out of recession. In a sense, it is odd that the power of fiscal policy has come as a surprise – or that it continues to be categorically denied by the German government and the U.S. Tea Party. The underlying reason why fiscal policy is so important in recessions, and has now come to dominate over monetary policy, is a matter of simple arithmetic that should not be open to debate. [Emphasis added.]


As monetary policy has lost traction, fiscal policy has automatically gained power. With interest rates at or near zero, private demand cannot be simulated with further rate cuts and this means that monetary easing can no longer offset fiscal tightening. As a result, any reduction in budget deficits becomes unambiguously deflationary, which is why the French and Italian governments were right to resist enforcement of the German-inspired fiscal compact in the euro-zone. Conversely, fiscal expansion now provides an unqualified economic stimulus because there is no risk of interest rates rising significantly in the next year or two – and perhaps not until the end of the decade. In short, the world has returned to a period of fiscal dominance, as in the 1950s and 1960s.

Anatole Kaletsky, “The takeaway from six years of economic troubles? Keynes was right.“, Reuters, 31 October 2014.

Anatole Kaletsky (born 1952 in Moscow, USSR) is a journalist and financial economist based in the United Kingdom. He joined Reuters and The International Herald Tribune in 2012. He previously wrote for The Economist, the Financial Times and The Times of London. Mr Kaletsky is also chief economist of GaveKal Dragonomics, a Hong Kong-based group that provides investment analysis to financial institutions around the world. His book Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis (Perseus/Public Affairs, 2010) has been translated into Chinese, German, Korean and Portuguese.

HT Mark Thoma

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