The Great Depression

How the Federal Reserve caused the Great Recession


This column is slightly different from the ones I usually write. On most days the idea is to write on something which is currently happening. This column doesn’t fit that formula.

In this column I wanted to write about how our world view plays a huge part in what we think and the decisions that we make, and how those decisions can turn out to be majorly wrong in the long-term, even though when we were making them they seemed to be the perfectly correct thing to do.

The dotcom bubble started to burst in early 2000. Soon after on September 11, 2011, several airliners were hijacked, of which two flew into the iconic World Trade Center in New York and one into Pentagon. The American economy which was going through tough times in the aftermath of the dotcom bubble collapsing, got into even more trouble after 9/11.

Alan Greenspan, who was the Chairman of the Federal Reserve of the United States, at that point of time, recalls in his book The Age of Turbulence that the American economy had been in a minor recession for a period of seven months before September 2001. And in the aftermath of the attacks, the reports and statistics streaming in painted a very worrying picture.

Americans had stopped spending on everything other than the items they would need in case there were more attacks. Sales of grocery items had gone up; so had sales of security devices, insurance, and bottled water. On the flip side, businesses like travel, entertainment, hotels, tourism, and even automobiles were majorly hit.

The American economy is very consumer driven and if consumers stop spending, then the economic growth immediately collapses. This was likely to happen in the months that followed September 2001.

With spending collapsing, there was a danger of the minor recession turning into a major one. To prevent this, Greenspan, as he had in the past, decided to cut interest rates. The federal funds rate, which was at 3.5 percent before the attack, was cut four times and brought down to 1.75 percent by the end of the year, starting with the first rate cut of 50 basis points, or half a percentage point, on September 17, 2001, six days days after the attack. (One basis point is one hundredth of a percentage). The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans.

Central banks cut interest rates in the hope that consumers would borrow money to spend and businesses would borrow money to expand, and so the economy would grow. As James Rickards writes in The Death of Money—The Coming Collapse of the International Monetary System: “We all asked ourselves how we could help [in the aftermath of the attack]. The only advice we got from Washington was ‘get down to Disney World … take your families and enjoy life’.”

People did borrow and spend, but they went overboard with it. America’s new bubble after dot-com was real estate and it was built on the belief that anyone could make money in real estate. As Stephen D. King puts it in When the Money Runs Out: “The white heat of the 1990s technological revolution was replaced by the stone cold of a housing boom.”

Between January 2001 and mid-2003, the federal funds rate was cut by 550 basis points to one percent. The interest rate stayed at one percent for little over a year.

The Federal Reserve did not want the United States to become another Japan. Japan had been in a low growth environment since the collapse of the stock market and the real estate bubbles, starting in late 1989. Prices had been regularly falling. In an environment of falling prices(or deflation) consumers keep postponing consumption in the hope of getting a better deal in the future. This leads to businesses suffering and the economic growth collapsing.

Ben Bernanke, who would takeover as the Chairman of the Federal Reserve from Alan Greenspan in 2006, joined the Federal Reserve in 2002 as a governor. Bernanke was a scholar on the Great Depression of 1929.

In one of the first speeches that Bernanke made after joining the Federal Reserve he said: “Whenever we read newspaper reports about Japan, where what seems to be a relatively moderate deflation—a decline in consumer prices of about 1 percent per year—has been associated with years of painfully slow growth, rising joblessness, and apparently intractable financial problems in the banking and corporate sectors … the consensus view is that deflation has been an important negative factor in the Japanese slump… I believe that the chance of significant deflation in the United States in the foreseeable future is extremely small… So, having said that deflation in the United States is highly unlikely, I would be imprudent to rule out the possibility altogether.”

This fear of not becoming another Japan and at the same time not engineering another Great Depression led to the Federal Reserve keeping interest rates low much longer than it should have. This led to the real estate bubble which would finally start bursting in 2007-2008.

As Barry Eichengreen writes in his brilliant new book Hall of Mirrors—The Great Depression, The Great Recession and The Uses—And Misuses—Of History: “With benefit of hindsight, we can say that the Fed overestimated the risk of deflation and responded too preemptively and aggressively. As a student of Japan and of the Great Depression, Bernanke may have been overly sensitive to the danger of deflation at this point of time. In other words, history may be useful for informing the views of policy makers of how to respond to certain risks, but it may also shape and inform outlooks in ways that heighten other risks”

Bernanke’s world view led to the Federal Reserve keeping interest rates low much longer than it should have. Over and above this, the inflation data that was coming out at that point of time may also have had a role to play. As Eichengreen writes: “Distorted data may have also contributed to the Fed’s exaggerated concern with deflation. Contemporaneous data showed the personal consumption expenditure deflator[the inflation index that the Federal Reserve follows], cleansed of volatile food and fuel prices, falling to less than 1% in 2003, dangerously close to negative territory. Subsequent revisions revealed that inflation in fact had already bottomed out at 1.5% and was now safely on the rise.”

This led to Federal Reserve maintaining low interest rates, when it should have been raising them. In the process, the Fed ended up fuelling the real estate bubble, which finally led to the bankruptcy of Lehman Brothers in September 2008, and the start of the current financial crisis, which was followed by what is now known as the Great Recession.

The column originally appeared on The Daily Reckoning on May 29, 2015

'The Federal Reserve Learnt the Lessons Of The Great Depression'

Prof Randall Kroszner..

R Jagannathan and Vivek Kaul

Randall S Kroszner served as a Governor of the Federal Reserve System from March 2006 until January 2009. During his time as a member of the Federal Reserve Board, he chaired the committee on Supervision and Regulation of Banking Institutions and the committee on Consumer and Community Affairs. Kroszner was a member of the President’s Council of Economic Advisers (CEA) from 2001 to 2003. Currently he is the Norman R Bobins Professor of Economics at the University of Chicago Booth School of Business. He is an expert on international financial crises and the Great Depression. He was recently in India for the opening of The University of Chicago Center in Delhi. In this interview Kroszner tells Forbes India on how the Federal Reserve managed to avoid another Great Depression in 2008 and why it had to let the investment bank Lehman Brothers go bankrupt.

You were a governor at the Federal Reserve between 2006 and early 2009. That must have been a very tough and an exciting time…
Three easy years…(laughs). I am joking.
Can you give us some flavour of how those years were?
It was an incredibly challenging time because the markets were moving so rapidly. The economy was also moving rapidly downward. So we had to take important decisions in real time. We would often get into situations where we would try to survive until Friday and then try to do the resolution by Sunday, before the Asian markets opened. So we had a lot of board meetings late on Fridays, Saturdays and Sundays. And it was a time where having an economic framework was very useful because when you have to make decisions in real time, you need to have a framework to understand what the priorities are.
You and Ben Bernanke are scholars of the Great Depression. How did that help?
A number of us were quite familiar with the economic history. Three out of the five of us on the board had written papers on the Great Depression. And we were all pretty much influenced by Milton Friedman and Anna Scwartz’s magisterial A Monetary History of the United States. Their study squarely put the blame on the inaction of the Federal Reserve, turning a depression into the Great Depression. Those were very important lessons for us and gave us both an economic and historical framework for looking into the kind of price distress we were having at that point of time, so that we could act quickly and boldly to prevent a repeat of the Great Depression.
Did you all really believe that if the fiscal side and the monetary hadn’t acted as they did in 2008, you were really seeing a repeat of the Great Depression?
There was a certainly a risk of that because clearly there was a lot of turmoil in the financial markets. There was a potential for failure of many financial institutions, if the Fed did nothing and did not provide liquidity to the market and some institutions. It was by no means a certainty. Even if the probability was low, it’s a risk that I and other members of the Federal Reserve board were reluctant to take.
In the meetings at the Fed before September 2008 what was the atmosphere like? Did Chairman Bernanke and other governors have a clue of what was to come?
If you see the verbatim transcripts of 2008 many of us including myself were very concerned about the fragility of the market and the economy. We undertook some very bold action in terms of a very rapid interest rate cut. This was at a time when the European central banks were raising interest rates because oil prices were rising throughout 2008. But our forecast was that demand was likely to go down significantly and that the rise in oil prices was just a temporary price shift not suggesting an underlying increase in inflation. And that is why we had interest rates very low during that time period while other central banks were raising interest rates.
Being the Chair of the committee on Supervision and Regulation of Banking Institutionsyou must have been in the room when a decision to let Lehman Brothers go bust would have been made. What was the atmosphere like?
So, there was no meeting where a go/no go was made. It was a series of processes. Remember we were dealing with independent investment banks having significant funding troubles and having great concerns about their ability to survive. And so we were exploring whether there could be merger partners for organisations like Merrill Lynch and Lehman Brothers. Bank of America decided to buy Merrill Lynch. There were others who were looking at Lehman Brothers and we thought that we would be finding a merger partner. But it then emerged over that weekend[the weekend of September 13-14, 2008] that a merger partner was not available for Lehman Brothers. The market had known that they were in trouble for a while. And Lehman Brothers had not been willing to merge with a number of other institutions that had proposed merger over the summer. Hence, it was in an effectively weak capital position. Its business model was imploding and so, the Fed was not able to do a capital infusion.
Why was that the case?
The Fed can only lend against good collateral to a solvent organisation. It was very difficult to make an assessment at that time. There was a merger partner avaialble for Merrill Lynch and Bank of America could provide capital infusion and support. Morgan Stanley and Goldman Sachs had sufficient capital and sufficiently functional business models, that we felt comfortable granting them bank charters on an emergency basis. But Lehman Brothers did not have that wherewithal.
But two days later Federal Reserve stepped into rescue AIG. How do you explain that?
Well remember that the Fed could lend against good collateral. The problematic part of AIG was the financial products subsidiary of the holding company. But AIG had other operations in many states and in many countries that were not associated with the challenges that were there in the financial products division. And also AIG had sufficient collateral to be able to post against the loan.
You are also a scholar of the Great Depression. What were the mistakes made during the Great Depression that haven’t been made during the period of what is now called the Great Recession?
As you know a number of us including Bernanke, myself and one of the other governors, were students of the Great Depression and had done work on it. Milton Friedman and Anna Scwartz’s in their magisterial book on the monetary history of the United States had said that depression of the late twenties and early thirties was turned into the Great Depression precisely because the Fed did not act. The Fed stood by as the money supply collapsed, and as deflation came in. The prices fell by a third, GDP fell by 30%, and unemployment went up to 20%, and there was no action.
And that was the lesson?
Yes. That was a very important lesson for those of us who had studied the Great Depression, to make sure that we did not make that mistake of inaction because the central bank can prevent deflation. Broadly, we certainly learned the lessons of the Great Depression at the Fed, to make sure that we didn’t make the same mistakes. We didn’t just sit ideally and allow the price level to fall significantly and allow the GDP to contract. Honestly, we were able to avoid a significant to recession. It is really something very different from what happened in the 1930s.
You also managed to avoid a deflation…
Deflation can be very destructive as we saw in the thirties. Even a mild deflation can be very problematic as we have seen over the last fifteen years in Japan. It was the strong commitment on the part those of us who studied the 1930s as supposed to the others, to make sure to not allow a state of inaction, where a central bank did not act as the lender of the last resort, which is actually what it was created to do. Further, central banks around the world have to be vigilant against the threat of deflation.
International financial crises is an area of your expertise. Why are economists unable to spot bubbles. Your colleague and Nobel laureate Eugene Fama has even gone to the extent of saying that “I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.”
It is easy ex-post to say that aha that price did not make any sense or it was clear that price would be coming down. But when in you are real time it is very difficult to be able to tell whether there is some sort of dislocation of the market or a fundamental change. We had the same challenge after the Asian, Russian and the Latin American crisis in the 1990s. The World Bank, IMF and many economists looked for indicators, so called red flags, which you could look at and tell when the economy is is getting overheated. They tried to figure out which are the indicators that can tell us that credit growth is too fast, or that there is a “bubble” in a particular sector. Despite a lot of work by a lot of very smart people on the policy side and the academic side, we really haven’t come up with a simple set of indicators or any indicator where you can have confidence and say just look at x, y and z, and you know that there is some sort of dislocation here, that is going to be reversed.
In a recent interview you said that the Fed’s approach to communication has changed through the years. Could you elaborate on that?
The communication has become more complete and more transparent and also the words have changed over time. They are sometimes called forward guidance. They are sometimes called open mouth operations because its talking about what kind of purchases and sales that the open market operations are going to do. In my last meeting at the Federal Open Market Committee(FOMC) we brought interest rates to approximately zero and said that we would keep them there for an extended period of time. That gradually changed into a particular date, and Fed would describe dates like 2014/2015. That changed to a description of 6.5% unemployment threshold. And most recently the Fed has said that it would not be focusing on a particular unemployment threshold.
What is the aim here?
I think all of the statements are trying to get at the same thing. It’s different words in different circumstances, around the same idea about the desire of the Fed to provide liquidity support to monetary accommodation to make sure that the economy fully recovers before it decides to take the punchbowl away. In these uncharted waters, giving a little bit more guidance about what the Federal Reserve thinks about policy making and how is it going to react to data is helpful because the past behaviour may not be that useful because we haven’t had these kinds of circumstances before.
In a recent interview when you were asked that when do you think the time will come when the Federal Reserve will start to raise interest rates, you had replied “I do think it will come sometime in my lifetime”. Does that mean the era of low interest rates in the US is here to stay? That was a bit of flip comment. I hope you understand that it was not meant seriously. We have had low interest rates for five to six years now. There is a hope that the economy will be strong enough sometime in 2015, and rates will be able to go up. You can see from most recent FOMC documents all of the FOMC members believe that the interest rates will be higher by the end of 2015 than they are now. And that sounds to me as reasonable.
A lot of gold bulls have been thinking that some point gold should have some role in money making. Do you see gold ever having any kind of role in monetary policy in future?
It’s narrow to pull this in any particular commodity because then the value of the currency will rise and fall depending on the vagaries of the particular market. So, like a flood in a mine in South Africa will have a big impact. And that is like putting too many eggs into one basket. The least you would want is a broader commodity based basket that would be well diversified and would be able to withstand these kind of shocks. So certainly thinking about alternative benchmarks for units of account are worthwhile to do. But I wouldn’t want to put all of my eggs in one particular commodity basket, particularly a market like gold which is a very small one. Small shocks like a flood in a mine in South Africa could have a big impact on money supply. Hence, it doesn’t seem like a very stable system.
The near zero interest rates and the QEs have had a bigger impact on the assets markets than the credit markets and the real economy. Would you say it is building up some problem?
It is important that the Fed is aware about this and is looking into this. Jeremy Stein one of the governors of the Fed has been at the forefront trying to think about what indicators to look at, indicators that might raise red flags. Jeremy as well as his staff are thinking very carefully about that. Monitoring this very very closely is very important and I know that the Fed is. To be able to predict which markets will have a dislocation, it is impossible to do that. No one has that kind of foresight. But I do think there is much more focus on that today than there was in the past.
In another five six months it will be six years since the Lehman Brothers went bust. How long do you think the easy money policies will continue?
As Chairman of the Federal Reserve, Ben Bernanke had said, whatever it takes, a corollary of that is as long as it takes. We have had a slow recovery than anyone had hoped for and that has been true not only in the US but many other countries as well. Some countries like India and some emerging markets that had done very well in the late 2000s have seen a significant fall in growth more recently. As the FOMC and Janet Yellen have said they are now on a path of tapering. It is very important to draw the distinction between tapering and tightening. The Fed had made a commitment to buy $85 billion worth of additional assets every month and that added nearly $1 trillion to the balance sheet every year. And with tapering now it is going to reduce the pace of that increase. So, it is not a tightening it just reducing the pace of additional accommodation. The additional accommodation is likely to wind down by the fourth quarter of this year and then depending on economic conditions, around six to nine months after that, the Fed might actually begin the process of tightening. But this is sort of a very gentle lengthy process. This is not a sudden shift of policy.

The interview originally appeared in the Forbes India magazine dated Jun 27, 2014

 

The wilful blindness of Manmohan Singh

Manmohan-Singh_0Vivek Kaul

The stock market crash of October 1929 started the Great Depression in the United States, from where it spread to large parts of the world. Some of the best books on the Great Depression, which are still being read, started to appear only 25 years later.
My favourite book the Great Depression is The Great Crash 1929, written by John Kenneth Galbraith. The book was first published in 1954, twenty five years after the Depression started. Milton Friedman and Anna Schwartz’s A Monetary History of the United States, 1867-1960, which dealt with the Great Depression in considerable detail, came out only in 1963. This book set the agenda for how central banks around the world reacted to recessions.
In fact, books on the Great Depression are still being written. A recent favourite of mine is Lords of Finance—1929, The Great Depression, and The Bankers Who Broke the World, written by Liaquat Ahamed, which was published in 2009. It won many awards including the Pulitzer Prize for history. What is true about the Great Depression is also true about Mahatma Gandhi. Some of the best biographies on the Mahatma, like Gandhi Before India, have appeared in recent times.
Dear reader, before you start wondering why am I talking about the Great Depression and Gandhi, in a column which is supposedly on Manmohan Singh, allow me to explain. The point I am trying to make here is that the best history is usually written many years after something has happened. The gap is probably necessary to allow historians to iron out the noise. Also, over the years new sources of information appear, which were not available in the first place. For one, documents get declassified. At the same time, letters that the men and women being profiled wrote, appear in the public domain and so on.
Hence, the defining history on Manmohan Singh’s years as the Prime Minister of India will most probably be written a few decades from now. Having said that, it is easy to predict that historians won’t project Singh in a good light.
The story that one usually hears about Singh is that he was an honest man heading a dishonest and a corrupt government. While his ministers may have made money being corrupt, he never did. This is a very simplistic explanation of the entire scenario.
A major reason why Manmohan Singh survived as the Prime Minister of India for a full decade was because he was ‘wilfuly blind’ to a lot of nefarious activities happening around him. Wilful Blindess is a legal concept that was first applied in the British courts in 1861.
As Margaret Heffernan writes in Wilful Blindness- Why we ignore the obvious at our peril“A judge in Regina v. Sleep ruled that an accused could not be convicted for possession of government property unless the jury found that he either knew the goods came from government stores or had ‘wilfully shut his eyes to the fact’…Over time, a lot of other phrases came into play – deliberate or wilful ignorance, conscious avoidance and deliberate indifference. What they have all in common is the idea that there is an opportunity for knowledge and a responsibility to be informed, but it is shirked.”
Manmohan Singh’s decade long tenure as the Prime Minister needs to be viewed through the lens of wilful blindness. He was wilfully blind to A Raja running the telecom industry for his own benefit. Singh was also wilfully blind to the coalgate scam where coal mines were given away free to both public sector and private sector companies. In fact, he was the coal minister when a large number of mines were given away free.
In fact, as Heffernan writes “the law does not care why you remain ignorant, only that you do.” Also, on some occasions the wilful blindness comes from that “we focus so intently on the order that we are blind to everything else.” Singh was so focussed on following the orders of Sonia Gandhi, who was the actual head of the government, that he chose to remain ‘wilfully blind’ to all that was happening around him.
Interestingly, when Enron went bust in the early 2000s, Jeffrey Skilling and Kenneth Lay, the CEO and Chairman of Enron, pleaded that they just did not know what was going on in the company and hence, could not be held responsible for it.
Judge Lake who was hearing the case invoked the concept of wilful blindness. As he instructed the jury: “You may find that a defendant had knowledge of a fact if you find that the defendant deliberately closed his eyes to what would otherwise have been obvious to him. Knowledge can be inferred if the defendant deliberately blinded himself to the existence of a fact.”
The phrase to be marked in the above statement is “closed his eyes”. The only way Singh could not have known about what was happening around him was if he had closed his eyes to it.
“Magicians never reveal their secrets,” writes Scottish writer Ian Rankin in his latest crime thriller Saints of the Shadow Bible. Singh was no magician. If he wants history to treat him a little better than it actually might end up doing, it is best that he spends his years in retirement writing his memoirs of the ten years he spent as India’s Prime Minister, like Winston Churchill did.
Churchill in the years after the Second World War wrote his version of history of the Second World War and even won the Nobel Prize in Literature in 1953. Singh needs to do the same. That way history might also consider his point of view.

The article originally appeared in the June 2014 issue of Mutual Fund Insight

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected]) 

The ghost of Keynes

keynes_395
Vivek Kaul
Franklin D Roosevelt became the President of the United States in 1933, at the height of the Great Depression. Known for his no nonsense manner of speaking, Roosevelt is said to have remarked that “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.”
Those were the days when it was believed that governments should be balancing their budgets i.e. their income should be equal to their expenditure. Also, John Maynard Keynes, the most influential economist of the 20th century hadn’t gotten around to writing his magnum opus, The General Theory of Employment, Interest and Money, till then. The book would be published in 1936.
In this book, Keynes introduced a concept called the “paradox of thrift”.
As Paul Samuelson, the first American to win a Nobel Prize in economics, wrote in an early edition of his bestselling textbook “It is a paradox because in kindergarten we are all taught that thrift is always a good thing….And now comes a new generation of alleged financial experts who seem to be telling us…that the old virtues may be modern sins.”
What Keynes said was that when it comes to thrift or saving, the economics of an individual differed from the economics of the system as a whole. An individual saving more by cutting down on expenditure made tremendous sense. But when a society as a whole starts to save more then there is a problem. This is primarily because what is expenditure for one person is an income for someone else. Hence, when expenditures start to go down, incomes start to go down as well. In this way the aggregate demand of a society as a whole falls, impeding economic growth.
Keynes used the “paradox of thrift” to explain the Great Depression. He felt that cutting interest rates to low levels would not tempt either consumers or businesses to borrow and spend. Cutting taxes, so as people have more to spend was one way out. But the best way out of a depression was the government spending more money, and becoming the “spender of the last resort”. Also, it did not matter if the government ended up running a fiscal deficit in doing so. Fiscal deficit is the difference between what a government earns and what it spends.
After the stock market crash in late October 1929 which started the Great Depression, people’s perception of the future changed and this led them to cutting down on their expenditure. In 1930, consumer durable expenditure in America fell by over 20% and residential housing expenditure fell by 40%. This continued for the next two years and the economy contracted, leading to huge unemployment.
As per Keynes, the way out of this situation was for someone to spend more. The citizens and the businesses were not willing to spend more given the state of the economy. So, the only way out of this situation was for the government to spend more on public works and other programmes. This would act as a stimulus and thus cure the recession.
In fact in his book Keynes even went to the extent of saying “If the Treasury(i.e. The government) were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again…there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.”
In the later years this became famous as the “dig holes and fill them up” argument. During the time Keynes was expounding on his theory, it was already being practiced by Adolf Hitler, who had put 100,000 construction workers for the construction of Autobahn, a nationally coordinated motorway system in Germany, which was supposed to have no speed limits. Italy and Japan had also worked along similar lines.
Very soon Britain would end up doing what Keynes had been recommending. Great Britain had more or less done away with both its army and air force after the First World War. But the rise of Hitler led to a situation where massive defence capabilities had to be built in a very short period of time.
The Prime Minister Neville Chamberlain was in no position to raise taxes to finance the defence expenditure. What he did was instead borrow money from the public and by the time the Second World War started in 1939, the British fiscal deficit was already projected to be around £1billion.
The deficit spending which started to happen, even before the Second World War started, led to the British economy booming specially in south of England where ports and bases were being expanded and ammunition factories were being built.
This evidence left very little doubt in the minds of politicians, budding economists and people around the world that the economy worked like Keynes said it did. Keynesianism became the economic philosophy of the world for the next few decades.
Lest we come to the conclusion that Keynes was an advocate of government’s running fiscal deficits all the time, it needs to be clarified that his stated position was far from that. What Keynes believed in was that on an average the government budget should be balanced. This meant that during years of prosperity the governments should run budget surpluses. But when the environment was recessionary and things were not looking good, governments should spend more than what they earn and even run a fiscal deficit.
The politicians over the decades just took one part of Keynes’ argument and ran with it. The belief in running deficits in bad times became permanently etched in their minds. Meanwhile, they forgot that Keynes had also wanted them to run surpluses during good times.
So, the politicians ran deficits in good times and bigger deficits in bad times. This meant more and more borrowing. And that’s how the Western world ended up with all the debt, which has brought the world to the brink of an economic disaster. The way the ideas of Keynes have evovled, has cost the world dearly.
Keynes, of course, understood the power (or danger) of economic ideas and he wrote in The General Theory that “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”
Now, only if he knew that a lot of practical men(read politicians) in the years to come would become the slaves of his ‘distorted’ ideas. The ghost of Keynes is still haunting us.
This column originally appeared in the Wealth Insight Magazine edition dated October 1, 2013 
(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek)