A Real-Life Experiment in Hyper-Keynesianism
FROM FOREIGN AFFAIRS | APRIL 16, 2019
Most Americans learned in school that the New Deal, President Franklin Delano Roosevelt’s sweeping response to the Great Depression, was a turning point in U.S. history. For 90 years, the progressive projects and reforms collected under its rubric defined the role that government could play in society and the manner in which government spending could be used to combat economic crises. The New Deal set the standard for big government intervention. Then came the pandemic of 2020.
In the past few weeks, the U.S. Congress and Federal Reserve have moved to inject more than $6 trillion into the U.S. economy. European governments and the European Central Bank are spending and lending trillions more. Norway, Italy, France, and the United Kingdom are directly subsidizing private payrolls. All together, these efforts will amount to at least $10 trillion, or a quarter of annual economic activity in the United States and Europe. Asian states including China, Japan, and South Korea are undertaking similar efforts at equivalent scale.
Governments, in other words, are spending as if there will be zero economic output between now and sometime this summer. In the coming months, the bonanza of public spending will blur the lines, never clear to begin with, between the public and private sectors and transfer a large portion of the global economy onto government balance sheets. This level of spending has no precedent in history—not even close. Not in war. Not in peacetime. Not ever.
No one can say for certain if such efforts can save the U.S., European, or global economies, but there is reason to think they might. Either way, on the other side of this crisis, the supposed laws of government spending and lending will need to be rewritten from scratch.
AN UNTESTED THEORY
On May 28, 1934, the British economist John Maynard Keynes met with President Roosevelt at the White House. With the New Deal in full bloom and Roosevelt embracing a level of government spending and intervention in the economy that was then unprecedented in peacetime, one might have expected Keynes to commend the U.S. president for putting into practice Keynes’s own recommendations for how to escape a deep depression. Instead, the economist told Roosevelt, genially and respectfully, that he hadn’t done enough.
A few days later, Keynes wrote an op-ed in The New York Times arguing that in order to lift the United States out of the crevasse of the Great Depression, the government would have to dramatically increase spending and allow for higher deficits. But that was a bridge too far even for Roosevelt, whose administration was already doing more than any previous administration to prop up demand, create jobs, and restore confidence in the economy. For the next five years, spending levels remained roughly the same, totaling roughly $700 billion in today’s dollars for the whole period. And while the New Deal kept the slump from getting worse, it never quite restored growth and prosperity to pre-Depression levels.
Critics have pointed to the ambiguous results of each bout of public spending and argued that such interventions damage long-term economic health.
Later government spending programs, some of them outside the United States, were just as ambitious and sometimes more so. In the aftermath of World War II, the United Kingdom created a national health-care system. Nordic countries followed the United Kingdom’s example, and eventually the rest of Europe did, too. Europe also invested in extensive public education and housing programs, partly to heal the ravages of war and partly to hold the tide of communism at bay. In the United States, President Lyndon Johnson’s Great Society programs sought to raise the standard of living of all Americans in the 1960s. These programs cost trillions of dollars, but they were phased in slowly over the course of decades.
In the 1980s, many Western countries began to reduce government intervention in the economy. Starting with President Ronald Reagan, successive U.S. administrations attempted to cut back spending on entitlements. British Prime Minister Margaret Thatcher did the same in the United Kingdom. Even so, the belief in stimulus spending during economic crises endured. During the financial crisis of 2008–9, the U.S. government bailed out the banking, insurance, and auto industries at a cost of nearly $800 billion. Soon after, it authorized a stimulus package of similar size. European governments, hamstrung by German insistence on fiscal austerity and a European Central Bank with less power than the Federal Reserve, moved slower and spent less. The initial European Union bailout in 2008 amounted to less than $300 billion, though that figure grew over time with various central bank actions and moves by individual countries to shore up their economies.
Critics have pointed to the ambiguous results of each bout of public spending and argued that such interventions damage long-term economic health. Most economists agree that the New Deal restored public confidence and at least partially stabilized an economy in free fall, but there is considerable debate about whether it succeeded in lifting the economy out of the doldrums. The programs of the Great Society were even more controversial. They gave rise to ardent free-market views, first espoused by the University of Chicago economist Milton Friedman, that government spending dragged the economy down and that the market was best left to itself. Many conservatives have blamed Europe’s publicly funded safety net for dampening growth, productivity, and innovation. And the stimulus spending in 2008 and 2009 has been equally if not more controversial, with many free-market economists assailing what they saw as excessive and unnecessary government spending as one reason for the slow pace of the eventual recovery.
The U.S. government has authorized an experiment in hyper-Keynesianism so large that the best analogy comes from military doctrine.
The retort to these critiques has often been what Keynes said to Roosevelt in 1934: governments are not spending enough. Until now, that theory has been impossible to test. Governments can spend only what their publics will allow, and for nearly a century, publics have allowed spending of between five and ten percent of GDP (including expanded lending from central banks) in any given year, regardless of the severity of the crisis.
Now the U.S. government has authorized spending that amounts to one-third of annual GDP over a matter of months. Given the current rumblings about a potential $2 trillion infrastructure bill and more funding for direct economic stimulus, the total amount could end up being closer to 50 percent of annual GDP. That proportion is multiples greater than Keynes himself would have contemplated. It amounts to an experiment in hyper-Keynesianism so large that the best analogy comes from military doctrine. Articulated to varying degrees by former Secretary of Defense Caspar Weinberger and former Chairman of the Joint Chiefs of Staff Colin Powell, the doctrine of “overwhelming force” held that military might, if deemed necessary, should not be used gradually and haltingly, as it was in Vietnam, but overwhelmingly, as it was in Iraq in 1991 and 2003. So, too, are public funds being deployed with “overwhelming force”: the U.S. government is spending more than anyone thought possible, faster than anyone thought feasible, as it seeks to contain the economic damage caused by the novel coronavirus.
NO GOING BACK
Will it work? No one knows for sure, because none of the previous episodes of high government spending are comparable. This is a real-world experiment. But whatever the outcome, there will be no going back to the old ideological divides and economic debates about public spending and lending. The sheer scale of government expenditures around the world will likely force economists to rethink their “laws” of pricing, markets, and government balance sheets. The coronavirus crisis has collapsed—at least temporarily and perhaps permanently—the line between the public and private sectors. When all economic activity is halted, there is no free market. Whether government spending can tide the economy over to the point at which the free market begins to function again is the test governments are currently running. What is clear is that without this level of spending, the risk of true economic and societal collapse would be non-negligible.
Among the economic “laws” that will be tested and likely found wrong is that high levels of deficit spending (paid for by printing money) will trigger inflation. Not all or even most macroeconomists subscribe to this view, but up until the outbreak of the coronavirus it remained the prevailing orthodoxy of the political realm. International financial institutions preached fiscal responsibility, lest spendthrift countries end up with Zimbabwe-style hyperinflation. Now the entire world is rejecting this orthodoxy at once.
Another prevailing view that is likely to fall by the wayside is that excessive government spending will cripple economic growth and lead to vague but ominous “excesses.” The International Monetary Fund and the Deutsche Bundesbank have been preaching variants of this mantra for decades, which explains why Germany embraced austerity rather than spending in the wake of the 2008–9 financial crisis. But the Germans are spending as aggressively as anyone right now, and there is no reason to think they will stop.
With even the thrifty Germans running up large deficits, the idea of a golden ratio between a country’s GDP and its acceptable level of debt is likely to be abandoned as well. After the last financial crisis, economists concluded that a debt-to-GDP ratio of more than 60 percent would make a country less resilient in the face of economic shocks. And the higher the ratio, the more likely that a government would have to borrow at a higher rate.
Even before the coronavirus crisis, the notion of an optimal debt-to-GDP ratio was called into question. Japan had borrowed more heavily than most developed countries in recent years, with a debt-to-GDP ratio before the pandemic of nearly 230 percent, compared with the United States’ ratio of about 110 percent. But Japanese interest rates and inflation remained steady and even fell slightly—precisely the opposite of what traditional economic models predicted. Soon, Japan will be the norm rather than the exception, and its pre-coronavirus performance might actually bode well for countries that follow in its footsteps: a record of anemic growth but economic stability, low inflation, and widely shared affluence.
If heavy borrowing and spending make countries more like Japan than Zimbabwe, there is reason for optimism. But that is a best-case scenario. It is easy to conceive of grimmer ones. Government spending alone can’t indefinitely take the place of real-world economic activity, though it may be a vital palliative in the near term.
Grand social theories almost never get tested in the real world. Today they are. In the grip of the pandemic, governments are spending with overwhelming force to stave off economic collapse. Whether this grand experiment will work is unclear. But what is clear is that nothing else will.