Way back in 1996 I wrote an op ed piece for the business pages of the Toronto Globe and Mail in response to the anti-Keynesian musings of Terence Corcoran a business columnist for the Globe and Mail who was convinced that Keynes was dead and buried for good. Clearly I didn’t agree and I said so in my piece. I think the piece still speaks to some of the current situation so I am reprinting it in this post. It appeared in the Globe and Mail,  April 2, 1996.

Terence Corcoran is convinced that in the long run Keynesianism is dead. He could not be more wrong. In fact we are on the brink of a major revival of Keynes’s approach to policy. The suggestion that government spending cuts stimulate private investment other things being equal clearly violates both common sense and economic logic. Before people will invest, they need strong positive expectations about the future aggregate demand for the products and services their investments will produce. Keynes called these expectations “animal spirits.”

To the extent that government cuts withdraw purchasing power from the economy, as they must, since the saved revenues are being directed at deficit reduction, the only alternative source of domestic demand for these new products and services are the untapped savings of consumers and producers themselves, or the new incomes associated with the new investments. These incomes must initially be derived from bank loans  or entrepreneurial savings. Since in Mr. Corcoran’s vision savings fuel new investments, we have to look elsewhere for the source of demand. Workers laid off from the public sector cannot be the source, and the workers involved in producing the new investments are bound to be too few to buy all the goods and services produced. Where will the aggregate demand come from ?

The layoffs of public sector workers simply fuels the fear of other workers that they may suffer layoffs in the future. Consumers rationally assume that job security everywhere is lessened whenever downsizing and layoffs become the order of the day. What starts as a public sector depression quickly spreads to the economy as a whole. If downsizing is practiced by our trading partners increased foreign demand cannot be the source of the required demand. Whatever stimulus to investment is given by the spectre of government cuts and the vague promise of future tax cuts is quickly overwhelmed when entrepreneurs discover that aggregate demand is not up to their original expectations.

The resulting wave of bankruptcies ensures that in the future these products and services are not produced and national income adjusts downward to a level more commensurate with the higher unemployment and the increased propensity not to spend. Since more than two thirds of government spending are investments in human capital in the health, education and social services sector, simply cutting them to substitute private investments guarantees no new net investment.

The large budget deficits that Canada has been experiencing are the result of excessively high rates of real interest and the higher unemployment they generate. Budget deficits can only be stimulative if they are accompanied by low real rates of interest brought about by greater central bank accommodation of debt. The quickest way to crowd in investment and increase the growth rate is to cut interest rates and restore confidence to consumers that the days of downsizing are a thing of the past. The suggestion that cutbacks in the OECD countries  have not slowed growth, other things being equal, flies in the face of the experience of the past decade where elevated unemployment and depressed growth rates have been the predicament of virtually all G7 countries that have followed the monetarist model.

The last time the classical school of laissez-faire ruled the policy roost, it took ten years of depression and a world war to convince people that that classical economic thinking …might be flawed. Despite this abysmal record, half a century later we have forgotten the lesson. Keynes’s original dictum “in the long run we are all dead” could well turn out to be the signature of our age as well as his.

Fortunately, there are signs within academic economics and public policy analysis of a revival of Keynesian thinking. This time it will not be marred by Paul Samuelson’s misinterpretation of the Keynesian model that allowed stagflation to undermine the credibility of Keynes’s doctrine. In Samuelson’s version…(using the Keynesian cross diagram) inflation could only apppear( as excess aggregate demand )only…after full employment was reached. Keynes never believed this to be so, arguing that as the unemployment rate dropped, inflation would rise well before the full employment point.

As Hegel pointed out the owl of Minerva takes flight at dusk. The dark ages of elevated unemployment and unnecessary suffering will be lifted as the light of this change in thinking spreads from the academy. Mr.Corcoran’s column will join those of the writers of the 30s who applauded cuts in hard times as celebrated follies of the financial press.