Mr Keynes makes a return

The newspapers are full of comment pieces on the apparent return of Keynesian counter-cyclical demand management. The Treasury has been spinning all weekend their view that fast-forwarding capital spending is an option being considered to inject fresh demand into the circular flow as the economy hits the recession buffers. And Alastair Darling is quoted as saying that the Keynesian idea of using fiscal policy to actively boost demand during a downturn is a relevant today as it was in the past.

Government borrowing is set to surge higher in any event - simply allowing the automatic stabilisers of fiscal policy to work will do that. The latest ITEM economic forecast predicts that the UK budget deficit could balloon to over six per cent of GDP next year - more than twice the notional maximum implied by the EU fiscal stability pact. And new figures released today (20th October) show government borrowing on an enormous scale.

There are many public sector investment projects that can bring about important supply-side benefits as well as helping to stabilise demand. New schools and hospitals, extra spending on new social housing, investment in the next generation of nuclear power plants, huge construction projects linked to Cross-Rail and London 2012 will give a significant boost to output, profits and jobs in the depressed construction sector.

But there are risks with bringing back traditional Keynesian demand management.

1/ Public sector capital investment projects take months if not years to complete – it is not simply a question of turning on the spending tap. If the UK recession turns out to be shallow, the multiplier effects of higher investment spending on output and incomes may arrive when the economy is already in the upturn swing of the cycle.

2/ The financial markets may not respond well to a government losing its fiscal grip – expect sterling to come under more selling pressure. A lower currency is good news for exporters but increases the general price level via higher import prices.

3/ Expect the debate to rumble on about whether the government should increase spending – or choose alternative ways of stimulating demand. For example the Conservatives are suggesting a six month VAT holiday for businesses employing four people or less and also hinting that they would reduce employer national insurance contributions to cut the cost of keeping people on the payroll. Across the pond, the Bush administration opted to give millions of people a tax rebate worth around $1500.

As always in economics, there are many options available to a government that wants to use fiscal policy to manage demand at a time of great uncertainty. The Chancellor’s room for manoeuvre would have been so much greater had he and his predecessor Gordon Brown not allowed the fiscal numbers to worsen so much in the last six years.

Articles about Keynes in the newspapers

John Sloman
How to kick-start a faltering economy the Keynes way

Sean O’Grady in the Independent:
Keynes, the man to get the Government out of a crisis

Stephen King
Memo to Gordon… think radical and dump the Bank’s inflation target

Allegra Stratton and Ashley Seager
Darling invokes Keynes as he eases spending rules to fight recession

Edmund Conway
No surprise Keynes is back in fashion

The Times
Spend, spend, spend: Alistair Darling adopts John Maynard Keynes doctrine

Telegraph
In the long run, John Maynard Keynes is not the answer

Financial Times
Man in the News – John Maynard Keynes