The Problem with Keynes

The economist John Maynard Keynes argued that in a recession, when consumers and businesses stop spending, the government has to step in and spend to take up the slack, even if it is just hiring people to dig holes and fill them in again. At its core, that is the logic behind the administration’s stimulus spending, though to their credit they have found some things to do a bit more useful than digging holes and filling them in again..

But there is a problem with this approach that Keynes didn’t really address very well. If the government increases spending at the very time when tax revenues are falling, the additional money has to come from somewhere. The government has only three ways to get that extra money to spend:

1. It can raise taxes, which leaves people and businesses with even less money to spend, and so makes the recession worse.

2. It can borrow the money, which increases the debt load and the interest payments. But this only works if someone else in the world is in a position to lend the money, which may not be the case if other nations are also having a recession.

3. It can print money, which leads to rapid inflation, making businesses and individuals even poorer and less able to spend (though it does in effect reduce the debt load).

Thus far, the administration has followed option 2. That will work so long as there is a reasonable market for US Treasury notes. If that market collapses, options 1 and 3 are all that is left, and the government would probably pick option 3. And then we will be in real trouble……!