The title of my book-in-progress, The Economic Consequences of the Pandemic is obviously meant as an allusion to Keynes’ The Economic Consequences of the Peace, and one of the central messages will be the need to resist austerity policies of the kind Keynes criticised in his major work, The General Theory of Employment Interest and Money. That title, in turn was an allusion to Einstein*, and the Special and General theories of Relativity.
The special theory Keynes wanted to replace was that of classical economics, in which the economy always tends to full employment unless governments or unions get in the way. The implication of classical economics, articulated in the Great Depression by Mellon (“liquidate the rottenness”) and in the Lesser Depression by the advocates of “expansionary austerity” is that the correct government response to a recession is to cut taxes, cut spending even more so as to balance the budget, and let the private sector expand as it naturally will.
The disastrous failure of austerity, particularly in Europe, has put its advocates on the defensive. Nevertheless, the idea that deficits are always bad has plenty of intuitive appeal (think of Angela Merkel’s Swabian housewife carefully balancing the household books). Austerity has an even stronger hold on those in the policy elite whose thinking was formed in the “inter-crisis” period between the breakdown of the Bretton Woods system in the early 1970s and the Global Financial Crisis of 2008. That accounts for just about everyone in the political class aged over 40, with the exception of a handful of people who have stuck to positions taken in the 1960s or just afterwards, such as Jeremy Corbyn and Bernie Sanders** .
Public expenditure has expanded everywhere in response to the pandemic, and the need for more spending is going continue long after the pandemic is controlled, either by continued restrictions or the development of a vaccine. The fight against austerity will begin with the expiry of time-limited emergency measures, which will happen in the second half of this year (September in Australia and much sooner in the US).
But if we can fight off the push for austerity, there’s another special theory that needs to be dealt with. Modern Monetary Theory (MMT) is, in essence, based on the assumption that the economy is always in what Keynes called a “liquidity trap”. This is a situation where the economy is so depressed that cutting interest rates to zero has no effect on demand – people pile up money rather than spending it. The only solution is for the government to spend money creating jobs (expansionary fiscal policy). And, as long as the liquidity trap continues, governments can keep increasing spending, financed either by money creation or zero-interest bonds.
The problem with this special theory is that a successful application implies destroying the conditions under which it works. Once the economy reaches full employment, any increase in public expenditure requires a corresponding reduction in private expenditure. The only sustainable way of achieving this is through taxation, and the only just way of doing it is through progressive taxation, with those in the top decile of the income distribution giving up a bit more consumption, and those in the top 1 per cent giving up a lot more. MMT advocates, like Stephanie Kelton kind-of admit this, but continuously seek to dodge the point. Here for example MMT advocates Nersiyan and Wray suggest that the Green New Deal can be financed without “taxing the rich” (a problematic term for progressive income taxation, since so few people admit to being rich) relying instead on “well-targeted taxes, wage and price controls, rationing, and voluntary saving”. “Well-targeted taxes” turns out to be a euphemism for a payroll tax surcharge, the most regressive form of broad-based tax.
Nersiyan and Wray draw on Keynes’ proposals in “How to Pay for the War”, which do include measures such as rationing and deferred pay, as well as large trade deficits. But the central point underlying Keynes analysis was that the war could not last forever. One way or another, the struggle with Hitler would be decided. In these circumstances, and with the total mobilisation needed for a life-or-death struggle, measures like deferred pay and rationing represent a way of sharing a necessary sacrifice. These were additional to, not a substitute for, steep increases in income and consumption taxes
A permanent change, like the original New Deal or a Green New Deal can’t be sustained with temporary wartime expedients or expansionary fiscal policy. What is needed is a transfer of resources from private consumption and privately directed investment to public use. That can be achieved through various forms of predistribution, reducing the incomes of those receiving an excessive reward at present, or through taxation. While both need to be pursued, it’s unlikely that predistribution can do all the work.
Keynes got this right in 1937, when he said “the boom not the slump is the time for austerity at the Treasury”.
*This just struck me, but of course I’m not the first to notice. Here’s James K Galbraith, attributing it to Robert Skidelsky. Still, good company to be in and Galbraith says not many others have made this point. And, it has been pointed out on Twitter, Pigou made much the same point in his critical 1936 review.
** If I had ever achieved any political influence, I would also fall into the category