An absolutely fascinating argument

I\’d hesitate to insist that it is absolutely true but….

As can be seen (from the above chart) there was a step change in the US economy’s indebtedness from the early 1980s onwards and then an additional one in the late 1990s/early 2000s. A similar picture is apparent across most of the Western World.

Basically from the early 1980s to the onset of the Global Financial Crisis the economy added on more debt every year and business cycles were extended as a result. Indeed the Fed and Central Banks around the world were afforded the luxury of operating in a secular falling inflation regime (globalisation) that allowed them to cut rates, further allowing the accumulation of debt, every time the economy may have naturally been rolling over into a normal recession consistent with those seen through history. This debt accumulation undoubtedly helped smooth the business cycle and contributed to the period being known as the ‘Great Moderation’. This period came to a spectacular end with the onset of the crisis and it is possible that going forward we will revert to seeing business/credit cycles more like they were prior to the ‘Great Moderation’.

One way of reading this is as the failure in the real world of the central tenet of Keynesianism.

Yes, OK, we should use the tools available, both monetary and fiscal, to make sure that we don\’t have recessions, that we don\’t end up with periods in which resources are unused. And certainly, if we do end up in such times we should use such tools to get out of such times.

Now note something important here: Keynes did not say that only fiscal tools could be used. He said we should use them when monetary tools are no longer effective: use the monetary tools first, when and where you can, then use fiscal when they don\’t work.

OK, sticking straight with standard Keynesianism. When we don\’t have such bad times we should be employing, both in monetary and fiscal terms, the tools which mitigate the boom. Partly because we want to do this anyway and partly because we want to pay back the debt we used to get out of the bad times.


But, what if there\’s something about politics, the pressures upon democratic politicians to buy support, that means that in the good times we never do in fact do this contractionary bit?

That every time we\’re in a boom the pressure is to keep the boom going rather than, as ( I think it was Volker saying it of a central banker\’s main job) taking away the punchbowl just as the party got going? Then the whole structure doesn\’t work, does it? We end up having the boom lasting way, waaaay, too long and then the crash, when it comes (for such are inevtiable given those \”animal spirits\” of which Keynes spoke) is larger than hte system can cope with.

In short, we\’d have been better off in having the usual short and shallow recessions instead of the long boom and now the, well, whatever you want to call it.

The argument ends up with Keynsian economics not being incompatible with economics, but with it being incompatible with politics in a democracy. Maybe it would work if we had Paul Krugman running the country for us. But since we don\’t, since handing such power to technocrats is entirely incompatible with what we regard as the right way to allocate power, then the theory dies, doesn\’t it?

In short, Keynesianism works for fascists* but not for democrats.

*And it did, for both Hitler and Mussolini.….

5 comments on “An absolutely fascinating argument

  1. Keynes did write a forward to the German version of the General Theory saying something along those lines (

    But the argument you present here applies more to a Friedmanite monetary policy, doesn’t it? Edward’s chart shows the US governments fiscal policy would have to have been enormously in surplus (an amount politically unacceptable to left or right) to have made a huge differenmce.

    Tim adds: “Edward’s chart shows the US governments fiscal policy would have to have been enormously in surplus (an amount politically unacceptable to left or right) to have made a huge differenmce.”

    Well, yes, that’s rather the point. Proper Keynesianism isn’t politically possible….

  2. Actually I misread Keynes’ introduction – he is saying it is easier to adapt to totalitarian states than the theory of laissez-faire would be. But I vaguely remember something about him saying it was suited to such states – maybe the Italian version.

  3. Maybe thats the plan, War! sort out the demographic time bomb, create another 50 years of demand and Robert Skidelsky gets to be more smug than normal.

    I knew those escape hatches in my cellar built in 1941 would come in handy sometime, not bothered about losing by beautiful iron railings though.

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