If you’re exposed to political economic discussions at all, you’ve probably heard the dispute about whether government spending can create jobs. The policy implication is whether government should spend more to boost the economy out of recession.
Studying the Great Depression, economist John Keynes proposed that during a deep recession with high unemployment government could speed the recovery by a fiscal (budgetary) policy of borrowing and spending. When the economy is down, the government is still a trusted borrower, while individuals and most companies are not. Further, the government can invest in infrastructure and other long-term projects, while workers are likely pinching pennies or worse, and companies are rationally holding back from investment while their existing factories are partly idle.
During several recessions, this fiscal policy of government deficit spending has been tried, and for many cycles over many years was considered successful.
In recent years, the political discussion has been re-focused more on shrinking government, shrinking taxes, and limiting government recession response to monetary (central bank) action, if that. One pivotal argument against Keynes’ theory was that government borrowing for stimulus would compete with private borrowing for productive investment.
Particularly in this most recent recession, which we entered in 2007 with an unprecedented large government debt and annual deficit, one political faction has called for deficit cutting (fiscal consolidation) above all other economic goals. This theory explicitly contradicts Keynes.
Jonathan Portes, Director of Britain’s National Institute of Economic and Social Research, and previously Britain’s Chief Economist at the Cabinet Office, has written an excellent summary of the interpretation and application of Keynes’ ideas today. It’s very well written and only a little bit technical, so if you’ve read anything about economics you should enjoy it.
A quote, itself quoted from recent comments from the International Monetary Fund:
‘”Fiscal consolidation typically lowers growth in the short term. …[A]fter two years, a budget deficit cut of 1% of GDP tends to lower output by about 0.5% and raise the unemployment rate by one third of a percentage point.” … “[fiscal consolidation] is clearly a drag on demand, it is a drag on growth”‘
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Fiscal policy: What does â€˜Keynesianâ€™ mean?