It’s back! Eighty years after John Maynard Keynes stuck a stake through its heart, the “treasury view” is once again threatening to derail our economy. It is as if, a century after Copernicus, astronomers were still convinced the sun circles the earth.
In the midst of the weakest economy in decades, George Osborne, Vince Cable and the G20 proclaim their first priority is to cut government spending and restore fiscal balance. Keynes, enemy of the “treasury view”, recognized back in the 30s that the cause of the great depression was insufficient demand. When consumers aren’t buying, entrepreneurs have no incentive to produce. They will then fire workers, causing demand to collapse even more. That vicious cycle of insufficient demand causing unemployment causing even less demand is the basis of all recessions.
Keynes saw the solution: fiscal stimulus. If the private sector cannot provide enough aggregate demand, then the public sector must step in. Even hiring men to dig ditches and hiring other men to fill them up is better than doing nothing. Those workers will spend their paychecks, sales will go up, businesses will need to replenish inventory, the private sector will again hire workers and the downward spiral of depression can be broken.
At the time, Keynes’ theories were revolutionary. The conventional view was piquantly expressed by Andrew Mellon, the dour secretary of the US treasury, who saw 25% unemployment as a deserved punishment for the excesses of the previous decade. “Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate. It will purge the rottenness out of the system,” he told Herbert Hoover. For Mellon, austerity and a balanced budget were the prerequisites of financial recovery. He believed that pain, precisely because it was painful, had to be beneficial.
World war two proved Mellon wrong. The United States emerged from the great depression not in spite of but because of unprecedented government budget deficits. War, after all, is the only activity even less productive than hiring workers to dig holes and others to fill them in. For several generations, economics students were taught to scoff at the naivete of the “treasury view”.
So why is the chancellor of the exchequer convinced that despite a weak economy, low inflation, and spectacularly low bond yields, we need to cut spending and cut it now? Since the end of the bubble, increased government spending both here and in America has helped keep the economy from collapsing. Today, our income exceeds our consumption by 10%. The private sector is saving, not spending—if the government joins in with the frugality, where is demand supposed to come from?
The expressed rationale for budget cuts is to reassure bondholders but so far, the bond market doesn’t seem particularly frightened. Interest rates remain infinitesimal and bondholders are not fleeing government debt but instead fleeing everything else. Yes, government debt levels are unusually high, but it is only academics and politicians, not the bond market, that express concerns over the solvency of states. Investors’ money keeps flowing happily into sovereign debt.
I think the appeal of the “treasury view” is not intellectual but emotional. On some level, like Andrew Mellon, we feel we have gorged ourselves on spurious debt for the past generation and so we must purge ourselves in order to deserve absolution. Pain is its own reward. Unfortunately, higher unemployment and lower demand are precisely what we don’t need right now, and these deficit hawks are risking a very fragile recovery by focusing on an imaginary problem. Where is John Maynard Keynes when we need him—and where, we might ask, is Vince Cable?