What was also odd was that this debate among the Keynesians made little mention of the main Keynesian policy: more government spending to restore economic growth. Krugman, Wren-Lewis, Rowe and Rognlie were only concerned with the efficacy of easy monetary policy. Yet this is the Keynes of the Treatise on Money written in 1931. After five more years of depression in the 1930s, Keynes then wrote The General Theory in which he recognised the failure of easy money policies and proposed fiscal spending instead, and even the ‘socialisation of investment’, as necessary to end the depression.
Ironically, there is a new report out which updates the analysis of the IMF economists of a few years ago who reckoned that they underestimated the ‘multiplier effect’ of austerity (fiscal contraction) on growth. At the time, this was made quite a fuss of by leftists within the labour movement, as it seemed to prove that austerity was the cause of the Great Recession and the ensuing depression.
In this blog, on several occasions, I have thrown some cold water over this conclusion and the role of the Keynesian multiplier. Well, the new analysis shows that the size of fiscal multiplier was not underestimated after all. “The authors do not find convincing evidence for stronger-than-expected fiscal multipliers for EU countries during the sovereign debt crisis (2012-2013) or during the tepid recovery thereafter.”
So the original IMF estimates were right that the multiplier effect of more or less government spending on growth was small and not larger during the period of ‘austerity’ policies adopted by various European governments since 2009. Keynesian monetary policy appears to have made little difference in restoring economic growth and incomes since 2009 and Keynesian fiscal policy would not either.
The Keynesians have a problem. Why has it taken so long to recover from the slump of 2008-9 even after central banks have applied Keynesian-style unconventional monetary policies? The answer from Britain’s leading Keynesian Simon Wren-Lewis and from America’s top Keynesian, Paul Krugman, is that capitalist economies in slumps are not self-correcting.
So we need central banks to apply easy money policies, especially when an economy is in a ‘liquidity trap’, where everybody holds cash and won’t spend. And when interest rates are at zero (zero-bound) and nothing happens, we then need ‘unconventional’ monetary policies like quantitative easing (printing money to buy government bonds from banks) or negative interest rates (charging banks for holding cash).
But even these policies are not working. The major economies are still growing well below previous trend growth rates and many still have not got their GDP per head levels back above pre-global crash…
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