A Tract on Monetary Reform

"That’s true up to a point. The problem is that most developed countries went into the financial crisis with structural deficits in their budgets. When you start from that position, it’s much harder to make Keynesian policies work. Part of the reason why we had deficits in the first place is that tolerance of deficits had come into Western economics through vulgar Keynesians. I use the term “vulgar Keynesian” deliberately, because I think Keynes would be rather appalled at the way his name is used these days to justify policies that are reckless. I think the notion that the solution to a property price crash or structural unemployment is simply one of even larger deficit than we’ve already seen – which in the US has been almost 10% of GDP for three years in a row – is not something that Keynes would have approved of. In his General Theory he is quite clear about the specific circumstances under which that kind of policy will work. One of Keynes’s points often missed by the vulgar Keynesians of our time is that you have to have a relatively closed economy for the stimulus to work. So there’s that. Then there’s the secondary point that many of the issues that we face are structural in nature. No amount of fiscal stimulus will get some people into work, if there is a mismatch between their skills and the skills that are required. I think the reality is that the fiscal crisis in the US hasn’t yet dawned, and it’s not entirely clear when it will, because the US in some ways benefits from the crisis enduring. But there will come a point when it loses credibility in the scale of its borrowings, and it’s very hard to say when that point will come. But come it will. The upper bound of how much it can borrow is reached when interest payments are at more than, say, a quarter of all tax revenues, and that can happen even if interest rates stay reasonably low. So I think we’re at the point when the problems that are inevitably going to arise haven’t yet hit. The main problem is that if you push the envelope so that it reaches, let’s say, 90% of GDP, then there comes a point when loans will not be given to you at the low rate you have got used to. When that happens, you go into the tailspin that Greece, Portugal, Spain and Italy are going into, and you have to tighten fiscal policy to reassure investors at the worst possible moment. So Keynes would have been alive to the limits of deficit finance under these circumstances. The only difference between the United States and Italy is that the US has the international currency, so it can do this stuff for longer. But it can’t do it interminably. At some point the US is going to encounter this contradiction. You need to have a combination of monetary and fiscal policies in a crisis like this. The reason why I cite Keynes’s earlier Tract on Monetary Reform is that Keynes was a very astute commentator on monetary policy as well as fiscal policy. I would ask the people who call themselves Keynesians to read Keynes. Or read, for example, the last volume of Robert Skidelsky’s wonderful biography . I’ve long revered Keynes’s intellect. I spent much of my time as a graduate student in an argument with him about German hyperinflation. That argument seems to me still to be relevant today, and one that people who quote him seem to have forgotten."