John Maynard Keynes and the idea of a relaunch.
Evidence of public spending?
Keynes’ logic was quite simple: revive consumption through public spending. Its stimulus model thus resulted in a multiplication of income. It’s the Keynesian multiplier. Keynes formalized a long tradition, as old as money, of public spending and deficits. World War I played a major role in instituting this belief that government can overspend and destabilize the free allocation of resources in the economy. However, his model quickly showed limitations.
In addition, it is important to understand the evolution of the economic context. In Keynes’ time, the liberal or neoclassical economic model predominated. That is to say, the weight of the state in the economy was naturally low. The table below, taken from “Gold and Silver”, shows the rate of public expenditure of states at the time of Keynes:
|Public expenditure (in% of GDP) and increase between 1928 and 1934. Source: IMF, database|
|United States||2.19%||3.06%||10.07%||+ 229%|
Between 1928, before the crisis of 1929, and 1934, the first notable slowdown of the Depression, the weight of public action in the American economy was multiplied by nearly 3.3 (+ 229% of public expenditure compared to the GDP). It is as if, in equivalent proportions, the American public services increased their public expenditure to 110% of the GDP in the face of a crisis in 2019. This increase is also considerable in France (+ 91%), in the Netherlands (+63 , 5%) and less relevant for the United Kingdom (+ 5.4% over the same period).
The structural limits to the Keynesian revival.
Today, public spending is much higher. Between 1910 and 2020, the rate of public expenditure to GDP has multiplied by 4 in the United Kingdom, by 6 in France, or even multiplied by 17 in the United States. Obviously, the current context makes budgetary policies structurally less effective, especially since indebtedness is much higher and deficits are out of control in balance. In addition, we can thus distinguish several limits to the Keynesian stimulus:
- Boosting demand is not necessary for all crises. The current crisis is a supply crisis: companies cannot produce. It is therefore by nature almost useless to finance a revival of demand.
- External consumption. Keynes’ world was hardly globalized. Today, it is impossible to greatly reduce the external commotion. An increase in the purchasing power of households will necessarily lead to the enrichment of foreign countries. External consumption alone dramatically reduces the Keynesian multiplier (fall in domestic consumption rate).
- Sustained drop in rates. A high level of deficit is only allowed by low rates. Keynes has never advocated keeping rates eternally low. In fact, keeping interest rates low automatically reduces inflation, and in the long term, potential growth. The reduction in potential growth limits the stimulus effect as much as the State budget blockage persists.
- High level of fiscal pressure, debt and public spending. An over-indebted state, which undertakes to spend up to half of the wealth produced by the country, cannot reduce its tax burden. A high tax burden considerably reduces the effectiveness of the stimulus. Likewise, high debt discourages consumption and reduces potential growth. Using short-term Keynesian policies simply reduces the effectiveness of long-term Keynesian policies. It’s mechanical (increase in public spending, tax pressure, etc.).
The growing ineffectiveness of stimulus policies.
In my last book “Gold and Silver”, I came back to the fact that budgetary or monetary expenditure mechanically made the following expenditure less efficient. Deficits and expansionary central bank policies only encourage the dynamics of indebtedness, falling growth, rates and inflation. Which requires an additional intervention and even a little less effective. This process leads to the sharp increase in liquidity and the price of most financial assets, mainly cryptocurrencies.
The graph above is extremely revealing of the real impact of stimulus policies on the economy. We observe in fact an extreme correlation between public deficits on the one hand and the speed of circulation of money or velocity on the other. In short, public spending mechanically reduces the use of money, which greatly reduces the potential for stimulus.
It should be noted that since the end of the 1990s, the velocity has fallen by nearly 50%! That is, every dollar received is twice as good to spend as it was 20 years ago. At the same time, the federal public deficit increased by almost 2000% compared to 2002! There is a real problem of efficiency. The scale of current monetary and fiscal policies reflects their chronic and gradual inefficiency. It’s cyclical.
The savings rate … Haunted governments.
One consequence of the fall in the use of currency in circulation is the rise in the savings rate. The rise in the savings rate also responds to the fact that for more than 20 years, real rates have been below growth. That is, if the rates give the illusion of abundant savings, then savings follow and consumption is reduced. The savings rate is one of the main parameters of Keynes’ stimulus model. A smaller increase in savings leads to a sharp drop in the effectiveness of the stimulus.
As absurd as it sounds, governments denounce the lack of consumption that they create on their own. The structural increase in the savings rate is a consequence of the rise in fiscal deficits on the one hand, and the continued fall in real rates and growth on the other.
Use of capital and economic dynamism.
Another aspect of the effectiveness of the stimulus is the rate of utilization of factors of production. (“Capacity Utilization” on the graph). If the machines are running at nearly 100% of their capacity, any stimulus adding demand will trigger strong inflationary drifts. However, if the factor utilization rate is low, a boost in demand may be relevant in the short term. However, in the long term, the situation is rather the opposite.
Since the 1980s, we have witnessed a sharp reduction in the capacity to use capital for companies. Capacity to use partly determines growth and inflation. As a result, the ability of firms to use the capital available to them largely depends on interest rates. The graph opposite shows a clear link between interest rates and capacity to use.
What this graph tends to show is that the continued fall in interest rates and inflation is leading to a reduction in capacity for use. For 20 years, it is mainly debt that has led to lower rates. As long as states run public deficits and debts, and as long as the weight of the private sector in the economy is reduced, user capacities should continue inexorably in their long-term trend. Weak utilization capacities are therefore the result of the recurrence of stimulus and support policies that lower potential growth. Here again, the effectiveness of the long-term stimulus is strongly impacted.
Obviously, the last 40 years are the result of over-interpreted Keynesianism in favor of states. The theory of counter-cyclical policies goes up in smoke as the States increase their support and stimulus excessively. This dynamic is not sustainable. It is time to urgently rethink the role of agents in the economy. Fiscal drifts slowly become monetary, which leads to increasing tensions between economic agents. States and central banks have crossed a point of no return in the dynamics encouraged. The scale of current fiscal and monetary policies is a reflection of their inefficiency. Finally, the impact on financial assets is very real and structurally benefits the development of certain markets (cryptocurrencies, etc.).