Ring! Ring! Oh, Mr. Keynes, It's An Emergency

According to one respected economist, a specter is haunting the industrial world: the growing threat of a downward slide into a depression reminiscent of the 1930s. And the best way to avoid such a disaster, he says, is to follow the advice of a man whose name still raises hackles in business and economic circles: John Maynard Keynes.

This view comes not from a liberal ideologue but from a resident scholar at a conservative think tank, the American Enterprise Institute. In a recent aei commentary, economist John H. Makin argues that fiscal orthodoxy--"the notion that reducing budget deficits is always a good idea"--is dominating global economic policymaking at the very time it seems clearly inappropriate.

Keynes' basic insight, notes Makin, was that government fiscal policy should be used actively as a "countercyclical" tool, both to counteract slowdowns via deficit expansion and to temper booms via budgetary restraint. Policymakers perverted Keynesianism in the 1960s and 1970s by failing to switch to fiscal restraint on the upside of the cycle, eventually causing inflation to explode.

The problem, says Makin, is that the trauma of that experience has led policymakers to reject the validity of Keynes's original message regarding the need for fiscal stimulus during contractions. Indeed, even as the sluggish world economy weakens further and inflation hits new lows, governments continue to favor deflationary fiscal policies.

Morgan Guaranty Trust Co. economists report that Belgium, France, Germany, Italy, Spain, Sweden, and other European nations are moving toward fiscal restraint (chart). Meanwhile, fiscal policy is only modestly stimulative in recession-wracked Britain. And in Japan, political wrangling and the threat of a widening deficit caused by falling tax receipts are delaying passage of budgetary stimulus.

The outlook for the U.S. is also problematic. Makin points out that fiscal policy was mildly stimulative in fiscal 1992 partly because the Bush Administration cut withholding-tax rates. But this will result in lower tax refunds and a swing to fiscal contraction in 1993.

The key question is whether Bill Clinton, who has vowed to shrink the deficit, can reverse this swing. Clinton's plan to shift both the tax burden and the direction of spending without raising the deficit would have little effect on the current fiscal drag in the budget. The best tack, says Makin, would be to front-load tax cuts to spur investment and spending and to tie them to firm commitments to cut back future entitlement spending. But such promises will be hard to sell to fiscal conservatives in Congress and wary financial markets.

In short, both ideological and political constraints seem to be leading the U.S. and other nations to ignore Keynes's original message and to follow policies of fiscal restraint in the face of weakening economies. "If these policies are pursued aggressively," warns Makin, "they could cause a global depression."

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