Whither Keynesianism?

A second problem with the Keynesian recommendations is that governments did not do enough to build up surpluses in good times. Many governments therefore are running out of fiscal space, or at least markets perceive that to be the case. Even if Keynesian theory says they ought to be expanding with their fiscal policy, they can’t always do so with impunity.

The recent history of the UK government is a paradigmatic example. Under Prime Minister Liz Truss, the plan was to boost spending on energy subsidies and cut some taxes. Whatever else you might say about the details of those policies, they did fit the Keynesian recipe for fiscal expansion in tough times (though it is noteworthy that many leading Keynesian economists strongly opposed them).

The problem is that markets didn’t like the policies, and the British pound fell and borrowing rates on government bonds rose. Financial markets were roiled, and now the Truss days are over.

Now Rishi Sunak is prime minister. What exactly is he supposed to do? He might try the opposite of the Truss plan, namely raise some taxes and cut some spending, or at least bend downwards the trajectories for future spending. In Keynesian terms, however, that policy is ill-advised. The UK is likely entering a recession, and the Bank of England has declared it may be the longest recession on record. Is it really wise to engage in austerity when times are turning bad?

Furthermore, the extant numbers do not indicate that the UK has to engage in austerity. Its debt-to-GDP ratio is about 80%, which is not astronomical. For a while economists Carmen Reinhart and Kenneth Rogoff tried to convince the profession that debt levels are dangerously high at 90% of GDP, but those arguments were shot down for having data errors and now those claims are discredited. It is not easy to now argue that a debt-to-GDP of 80% requires austerity.

Here is the remainder of my Bloomberg column on the topic.