What would JM Keynes think of the economic crisis today?

John Maynard Keynes was the twentieth century’s most influential economist and an intellectual giant during the Great Depression and Second World War. His famous General Theory established that government spending could dig an economy out of a slump.

At least that is how his thinking is remembered. In practice his work is very complicated and seldom actually read, and then there is the problem that Keynes was also famous for changing his mind.

Consumption or investment?

American Keynesians, for example, have always focused on the need to maintain consumption rather than investment which is actually what Keynes always favored. In 1944, after a meeting with them in Washington, Keynes commented that he was the only non-Keynesian in the room.

It is also difficult more than 60 years after his death to know what Keynes would have made of our modern globalized economy, although there are parallels with the globalization of the pre-First World War.

Would Keynes have approved of stimulus packages to tackle the immediate global economic crisis? Probably but only as an emergency measure. He would likely have spotted the build up of credit in the system that caused the crisis earlier than most, having observed the same thing in the 1920s. Indeed he warned about it then only to be ignored.

But if you read the General Theory’s index, and few get further than that, you find only six lines of references to boosting consumption through public spending. Keynes favored public investment in capital producing assets. That means building new highways or power plants, not bailing out a bloated banking sector.

His theory of the multiplier explains how focused investment spending has a much wider impact on the economy with people in work spending elsewhere, for example. It also points out that the withdrawal of public spending to balance the books has the reverse effect, and is particularly dangerous in an economic slump. But there is no hint that a general attempt to bail everybody out through managing consumption might work.

Debt solutions

However, he would likely favor the US approach of growing an economy out of debt rather than the European solution of austerity and public spending cuts, especially in current circumstances.

This has worked in the past. For example, the post-Second World War British economy carried a 240 per cent of GDP debt that fell to under 100 per cent 20 years later. Some of this was down to inflation but the real burden of the debt was cut by 80 per cent by growth.

These debt levels are not so far off what the US faces today. Will state spending cuts now undermine spending by the federation? It is certainly going to be a delicate balance moving forward, and a stock market predicting a rapid recovery is barking totally up the wrong tree.