For much of the post-war period, the ideas of British economist
John Maynard Keynes held sway in Western Finance Ministries and
Central Banks. Keynes believed that government should manage the
economy using fiscal policy – public borrowing, spending and
High inflation and weak growth in the 1970s undermined faith in
fiscal policy. The Reagan/Thatcher revolution of the 1980s
emphasised small government and put monetary policy at the heart of
economic management. Since then monetary policy has largely ruled
the policy roost.
Keynesianism saw a brief revival in 2009, in the midst of the
global financial crisis. Shocked by the severity of the downturn,
many governments reached for Keynesian programmes of public
spending. The boost to growth in 2009 amounted to an average of 2%
of GDP for the world's twenty largest economies. In the US a
newly elected President Obama enacted the American Recovery and
Reinvestment Act in which pumped the equivalent of 6% of US GDP
into the economy.
The global recovery has been patchy, but sufficient for most
governments to jettison Keynesian fiscal activism. Instead the
focus has been on cutting public sector borrowing through tax rises
and spending cuts. In recent years the austerity needed to reduce
public sector borrowing has acted as a drag on activity. Monetary
policy, in the form of ultra-low interest rates and Quantitative
Easing, have been left to do the heavy lifting of supporting
But today Mr Keynes is making a quiet comeback. This partly
reflects a growing belief that monetary policy is "running out
The ability of central banks to boost growth increasingly means
pushing interest rates into negative territory. In an inversion of
normal relationships central banks in the euro area, Japan,
Switzerland and Sweden already charge commercial banks to deposit
funds with them. Policymakers worry about the declining
effectiveness of monetary policy and the side effects –
pressure on savers, money flowing into high risk assets, such as
real estate, and the risks for banks (Negative interest rates
encourage businesses and households to hang on to cash, undermining
banks' ability to raise funds).
Fiscal policy offers an alternative way of boosting growth, and
with financing costs that are lower than for centuries. The private
sector pays the German and Japanese governments for the privilege
of lending them money for ten years. The UK, despite slow progress
in cutting borrowing and a post-referendum credit downgrade, can
raise money at the lowest rates in history, at a cost of just 0.8%
Surely, the argument runs, governments can find public sector
projects – such as infrastructure or education - which will
give society a higher return than the vanishingly low cost of
capital and, at the same time, will boost demand?
For all the talk of austerity most governments have been trying
to reduce the amount they borrow each year, not to reduce their
overall levels of borrowing. Outside a small group of countries,
including Germany and Canada, government debt has continued to
rise. Despite this, the private sector has become ever more
enthusiastic about lending to governments, and the cost of
borrowing has declined.
To a Keynesian all of this suggests that the problem is not too
much government borrowing or excessively high interest rates, but a
lack of demand. Uncertainty and weak demand discourage investment
and push money into the supposed safety of government bonds.
Correcting this requires more government spending.
These arguments seem to be gaining traction in unlikely
quarters. Donald Trump has outlined spending plans worth a whopping
2.5% of GDP. In a reversal of roles the Democratic candidate,
Hillary Clinton, is the voice of fiscal conservatism by offering
fiscal stimulus worth "only" 1.5% of GDP. The rhetoric of
austerity is out under the UK's new Chancellor, Philip Hammond
who seems likely to abandon his predecessor's plan to balance
the budget by 2020. And the Japanese government recently launched a
fiscal stimulus worth 1.3% of GDP.
Policymakers haven't given up on monetary stimulus, nor are
they placing all their bets on fiscal policy. But after several
years of tightening fiscal policy in the developed world is likely
to be slightly expansionary this year and next. The guardians of
the global economic order – the IMF and the OECD –
argue that countries with low borrowing costs should borrow to
invest. And politicians seem more receptive to spending, especially
for growth-enhancing projects such as infrastructure.
This is not so much a revolution as a tilt to easier fiscal
policy. It's a quiet comeback for Mr Keynes, but one that opens
up the possibility of more significant fiscal stimulus to come.
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