The Return of Keynes?

By Roland Bensted and Christian Nicholson

The financial crises since 2007 have led to a resurgence in the stock of John Maynard Keynes. Recognised as one of the giants of economics, Keynes had been overtaken and largely forgotten by the neo-classical economics that had dominated public policy since the 1980s.  Yet, Keynes’ concept of government stimulus spending became the go-to policy for a number of world governments desperate to avoid economic catastrophe. As Robert Lucas, a prominent member of the neo-classical orthodoxy, has dismissively remarked, “Everyone is a Keynesian in a foxhole”. Is this the limit to which Keynes is of use to us in the present? 

This article explores Keynes’s economics, arguing that he can shed much light on our present concerns. Keynes offers policy prescriptions to both immediate challenges, such as the European debt crisis, and longer term questions about the future of developed economies. Keynes is not only useful “in a foxhole”. Instead, he has a much wider relevance.

The enormous bank bailouts that were necessitated by the financial collapse that followed the September 2008 demise of Lehman Brothers have led to significant public deficits across Europe and many other countries of the world. While most observers agree that large deficits are not desirable, the alternative scenario after Lehman Brothers’ collapse would likely have been far worse: a global economic meltdown on the scale of the 1930s’ Great Depression. The immediacy of the crisis necessitated bank bailouts. Governments put into action Keynes’ prescriptions on deficit stimulus. Nearly three years after the coordinated government interventions of September 2008, this policy has once again become controversial and has even been abandoned in some cases. The mood has changed. For example, the strategy of the UK’s Conservative-led government has made austerity the focus of what it hopes will be a recovery. Even the US, which has pursued the stimulus most vigorously under Democratic President Barack Obama, who signed off on a US$787 billion economic stimulus package in February 2009, has recently reset some of its focus towards deficit reduction, even as its economy continues to struggle.

Keynes’ concern was how to secure socially and politically-as well as economically- acceptable outcomes following the far worse crisis that followed the Great Depression. Much of what is relevant now with regard to the eurozone comes from Keynes’s extensive writings on this era, including the machinations of the British return to the gold standard in 1925. Both the gold standard and the euro rigidly link(ed) the currencies of a diverse range of economies, primarily with a view toward providing price stability and enforcing a degree of monetary discipline on members. The analogy here is imperfect. The gold standard ensured currencies remained tied in value to the amount of physical material discovered - something Keynes termed “a barbarous relic” – whereas the euro is a currency that can be managed with some flexibility. Indeed, one of the criticisms of the euro relates to the lack of fiscal and political harmonisation to accompany monetary union. More importantly, member states cannot simply withdraw from the euro. As The Economist of 19 August 2010 noted, “Countries left the gold standard in wartime without much fuss.... Modern members of the euro cannot easily quit it”. Where Keynes can assist is in conceptualising the balance of priorities. Inevitably there are strong rationales on either side of the debate. What one must do is to seek to determine which are to be prioritised.

The harsh lending terms which Greece, Ireland and Portugal have been coerced into accepting in order that the euro be preserved accord closely with the strict economic straitjacket incurred by the UK during the period of its return to the gold standard. As Keynes elaborated in A Tract on Monetary Reform, the choice represents one between devaluation and deflation. However, in the cases of the UK in the gold standard between 1925 and 1931 and the present eurozone crisis it is the latter which has been pursued. As Keynes concludes in this study the former is both economically and- crucially- socially preferable. For Keynes, deflation benefits a small rentier class to the detriment of the majority of the population. Deflation produces higher unemployment and higher prices as well as suppressing growth, something that the peripheral eurozone economies are currently experiencing. As Keynes outlines in his most strident critique of the gold standard, ‘The Economic Consequences of Mr Churchill’ (Churchill was Chancellor in 1925), the social consequences for the majority of the population were extremely grave. As we now see in the eurozone, the required deflation in Greece, Ireland, Portugal and Spain to regain economic competitiveness has put arguably unsustainable pressure on their societies. Increasingly, the ongoing debate over the eurozone periphery- previously dominated by huge abstract numbers- is catching up to this fact.  

As is acknowledged above this analogy is not perfect. Whereas countries found it comparatively easy to leave the gold standard once Keynes retrospectively won his argument through tough experience the question of leaving the euro for any member is a much more complex proposition. As Barry Eichengreen points out, “(I) f a participating member state now decided to leave the euro area, no such precommitment would be possible. The very motivation for leaving would be to change the parity. And pressure from other member states would be ineffective by definition”. If an individual member state left the euro, nothing less than “(a) system-wide bank run” would follow.

Additionally, as outlined in a previous article there are a number of significant reasons to fight for the euro. However, as Keynes forcefully argues, concepts of fiscal rectitude should not be among these reasons, given the impact upon ordinary people in the affected societies. Similarly, the punishment narrative which underpins much of what is written about the so called “PIGS” of the eurozone periphery is arguably to look at the problem from the wrong direction; as Keynes states, “[w]hen a general cause operates those which are weak for other reasons are toppled over. But because an epidemic of influenza carries only those who have weak hearts, it is not permissible to say influenza is all to the good.”

The salient point, one of which Keynes was consistently mindful, is that economic policy cannot be divorced from social outcomes. A final quote from Keynes represents perhaps the best single piece of advice to Europe’s leaders as they attempt to deal with the significant present challenges. “One blames politicians not for inconsistency but for obstinacy. They are the interpreters, not the masters of our fate. It is their job, in short, to register the fait accompli”. The current task for Europe’s leaders is undoubtedly tough. Yet, according to Keynes’ advice, they can achieve better results by adopting flexible, pragmatic policies rather than sticking to rigid and ideologically–tinged positions. Having a plan B (and even a plan C or D) may prove to be essential.


Christian Nicholson is reading for an MA in International Relations at King's College London, having graduated with first class honours in War Studies, also at King's, in 2009. His research interests include state building and the impact of ideas in social sciences.


4 July 2011


Related Articles:

Roland Bensted, Can the Euro Survive? 

Panos Stasinopoulos, Europe Through the Looking Glass: Could the Debt Crisis Negate Decades of Integration?

David Bayon, The Markets Have Spoken