How the bastardisation of Keynes is still haunting us


Vivek Kaul

“So how does it feel to be an educated unemployed?” she asked.
Shikshit berozgar sounds much better,” I retorted. “Plus you are making a pot load of money anyway.”
“Ah. Where has the male ego gone?”
“Well, as long as you keep the money coming, ego can take a backseat.”
“On the subject of money I was reading somewhere about some Western economists recommending negative interest rates,” she said.
“ The idea is to charge people who let their money lying idle in a bank account,” I explained.
“Charge?”
“Yes. Say if you keep $1000 in your bank account and the negative interest rate is 2%, then at the end of the year your account will have $980 ($1000 – 2% of $1000).”
“Oh. But why?”
“So that instead of letting the money lay idle in the bank account people take it out and spend it.”
“And how will that help?”
“Well when people spend the money the demand for goods and services will go up. This in turn will mean more profits for businesses, which in turn may recruit more people and decrease unemployment.”
“Interesting. Where does this idea come from?”
“It comes from the concept of paradox of thrift which was first explained by John Maynard Keynes, an economist whose thinking had the most influence on economists and politicians of the twentieth century.”
“But why call it a paradox? Isn’t being thrifty or saving money a good thing?”
“Keynes thought that when it comes to saving what makes sense for an individual may not work for the economy. If an individual saves more he cuts down on his expenditure. If one person does this, it makes sense for him because he saves more money. But more people doing it creates a problem.”
“What problem?”
“What is expenditure for one person is income for someone else. When you buy your fancy makeup, a lot of people earn money. The shop you buy it from. The company that makes the brand you buy and so on. When you don’t the entire chain earns lesser.”
“Ah. Never thought about it that way.”
“So as everybody spends less, businesses see a fall in revenue. To stay competitive they start firing people, which leads to a further cut in spending. The unemployed obviously spend less. But so do others in the fear that they might be fired as well.”
“And all this is not good for the economy,” she said. “But how is it linked to negative interest rates?”
“Since the financial crisis started in 2008, people in Europe, America and even Japan, are not spending money. Hence the idea of negative interest rates has been put forward. People would rather spend the money than see its value go down.”
“But is that what Keynes suggested?”
“No. What Keynes had said was that consumers and firms would be unwilling to spend money in an environment where jobs are falling and demand is falling or is flat or growing at a very slow rate. So the government should become the “spender of the last resort” by coming up with a stimulus package.”
“Hmmm.”
“Keynes also said during recessions the government should not be trying to balance its budget i.e. match its income with expenditure. The logic being that taxes collected would anyway fall during a recession, if the government tried to match this with a cut in expenditure, it would squeeze the economy even more.”
“So Keynes advocated that governments run fiscal deficits,” she concluded.
“Not at all. Keynes believed that on an average the government budget should be balanced. This meant that during years of prosperity the governments should run budget surpluses i.e. earn more than what they spend. But when the economy wasn’t doing well governments should spend more than what they earn and hence run a fiscal deficit.”
“Okay. So the money saved during the good time could be spent during the bad times.”
“Yes. Keynes came up with this theory in his book The General Theory of Employment, Interest and Money in 1936. This book had ideas based on the study of the Great Depression. During those days it was not fashionable for governments to run fiscal deficits as it is today. As Franklin Roosevelt, the then President of America put it “Any government, like any family, can, for a year, spend a little more than it earns. But you know and I know that a continuation of that habit means the poorhouse.” But then attitudes changed.”
“How was that?”
“As governments around the world got ready to fight the Second World War they spent a lot of money in getting ready for it, which meant they ended with fiscal deficits. Economies around the world which were still in the doldrums because of the Great Depression, suddenly started rebounding,” I explained.
“And so the star of Keynes shone?”
“Yes. But the politicians over the decades just took one part of Keynes’ advice and ran with it. The belief in running deficits in bad times became permanently etched in their minds. In the meanwhile they forgot that Keynes had also wanted them to be running surpluses during good times. So they ran deficits in good times and bigger deficits in bad times. This meant more and more borrowing. And this how the Western world has ended up with all the debt which has brought the whole world to the brink of a huge economic disaster.”
“But what about negative interest rates?” she asked. “Will they help?”
“Not really.”
“Why?”
“See the thing is other than government debts increasing in the Western world, the debt of individuals has also gone up over the years. So right now they by not spending they are saving money so that they can repay their debts.”
“Hmmm. But do you see negative interest rates coming in?”
“On the face of it I don’t think that will happen,” I replied. “But then you never know. Politicians have bastardised Keynes in the past. They can do it again.”
“How sure are you of this?” she asked.
“Let me answer your question with a couplet written by Javed Akhtar “main khud bhi sochta hoon ye kya mera haal hai, jiska jawab chahiye wo kya sawal hai.
(The interview was originally published on May 14,2012, in the Daily News and Analysis (DNA). http://www.dnaindia.com/analysis/column_how-the-bastardisation-of-keynes-is-still-haunting-us_1688370).
(Vivek Kaul is a writer and can be reached at [email protected]m)