Swan on Keynesian policy

Wayne Swan has a Fabian Essay defending the Keynesian credentials of the Rudd and Gillard government. The central argument is sound enough

if we are going to be Keynesians in the downturn, we have to be Keynesians on the way up again. That means a speedy return to surplus.

But there are a couple of big problems. The first is one of timing. The 2009-10 Budget, which included a large deficit as a Keynesian stimulus, proposed a return to surplus by 2015-16. This was seen at the time as quite ambitious – most developed countries have no obvious path back to surplus.

Nevertheless, by May 2010, with economic conditions much stronger than expected, it seemed as if the government had not been ambitious enough and the target date was brought forward to 2012-13.

Over the past year, however, the economic news, both locally and globally, has mostly been bad, with natural disasters producing short-term shocks, and the US and Europe mired in heavy debt and sluggish recovery. The economy has slowed a bit and tax revenue has fallen short of expectations. Unsurprisingly, on the government’s current policy settings, the return to surplus would be delayed, though probably still ahead of the original 2015-16 target.

From a Keynesian point of view, that’s exactly what should happen. Although the slowdown isn’t enough to justify an active fiscal stimulus, the standard Keynesian prescription would be to allow the automatic stabilizers to work, smoothing the path back to full economic recovery. Unfortunately, that’s not what the government is doing.

Rather than adjust the target to reflect the fact that the strong conditions of last year have not been sustained, the government is planning sharp spending cuts, not justified by any evaluation of costs and benefits, to ensure that the target is met on the new timetable. This is a fairly typical example, as is this.

An even bigger problem, reflected in Swan’s rhetoric about “making way for the private sector” in the recovery is the government’s insistence on holding down the size of the public sector relative to national income. This is a repetition of the ‘Trilogy’ commitment made by the Hawke–Keating government in 1984.

But (although Swan understandably skates over the fact) the Hawke-Keating government was explicitly anti-Keynesian at least until the later stages of the recession that began in 1989. The Trilogy reflected the policy thinking of the time, which was dominated by the then-ascendent ideology of new classical macroeconomics, market liberalism and financial deregulation. Anti-Keynesian ideas such as ‘crowding out’ were part of this ideology.

As Kevin Rudd observed in his much-cited Monthly Essay, such thinking was discredited by the Global Financial Crisis. The crisis demonstrated the dependence of modern economies on the ability of the state to act as a financier of last resort and as a source of fiscal stimulus.

In these circumstances, there is no justification for holding down the size of the public sector if it means rejecting policies for which the benefits outweigh the costs. Given the growing importance of health, education and other services largely funded by the public, we should expect to see the share of the public sector growing over time.

Unfortunately, Rudd and Swan did not act on this logic in the 2009 budget, promising to balance the budget primarily by holding down saving. And in this respect, unlike the timing of the return to surplus, the government’s position has been consistent.

A genuine revival of Keynesianism requires a hard look at all the ideas that came to be taken for granted during the era when market liberalism carried all before it. These ideas produced the global financial crisis, and were discredited by it. Nevertheless, they continue to wander in zombie form through the arguments even of professed Keynesians like Swan.

27 thoughts on “Swan on Keynesian policy

  1. As a fledgling post-Keynesian (MMT School), I disagree with

    Although the slowdown isn’t enough to justify an active fiscal stimulus

    but I agree with everything else you’ve said, Prof Quiggin.

  2. Nicholas Gruen :
    John, you may deplore the distributional consequences of a faster return to surplus, but I can’t see the problem on macroeconomic grounds. Do you fear it will depress employment? If so couldn’t looser monetary policy counterbalance that? Would you object to returning the budget to surplus by 2012-13 by raising taxes on the well to do? Would it be poor macro-economic policy?

    Hi Nick, I know you didn’t ask me and I’m by no means a professional (in any economic capacity) but the answer to your questions in order are Yes. No. Yes. Yes.

    Looser monetary policy will work in some areas but not others, its a blunt instrument. On hiking taxes on the well-to-do, in your own work you note they’re not a broad base and this wouldn’t be efficient. It would only encourage tax evasion and probably prevent investment.

    Greater employment (less underemployment) leads to Greater tax revenues which leads to lower deficits,which can possibly lead to accelerating inflation and thus a surplus is required to withdraw some of that spending power from the formerly underemployed.

    Otherwise a surplus just draws taxes from those that can least afford it and creates more underemployment as those that need to spend can no longer spend as much driving up unemployment.

    I believe Gillard/Swan are relying on another commodity bubble (and with worldwide disasters, it is likely) to export their way out of the situation which goes straight to @jrbarch‘s point.

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