(A fair-weather friend, this one. By accident he sat down next to me on
the Ottawa-Washington shuttle ten years and three months ago, a couple
of days after Mahathir imposed exchange controls, and I asked, "Are you
a Keynesian?". The straightforward, rapid reply: "No".)
Business Day
11 December 2008
Ensuring results now that we are all Keynesians
Joseph Stiglitz
WE ARE all Keynesians now. Even the right in the US has joined the
Keynesian camp with unbridled enthusiasm and on a scale that at one time
would have been truly unimaginable.
For those of us who claimed some connection to the Keynesian tradition,
this is a moment of triumph. At one level, what is happening now is a
triumph of reason and evidence over ideology and interests.
Economic theory had long explained why unfettered markets were not
self-correcting and why regulation was needed. But many pushed a type of
“market fundamentalism”. The misguided policies that resulted had
earlier inflicted enormous costs on developing countries. The moment of
enlightenment came only when those policies also began inflicting costs
on the US and other advanced industrial countries.
Keynes argued not only that markets are not self-correcting, but that in
a severe downturn, monetary policy was likely to be ineffective. Fiscal
policy was required. But not all fiscal policies are equivalent. In the
US today, with an overhang of household debt and high uncertainty, tax
cuts are likely to be ineffective. Much, if not most, of last February’s
US tax cut went into savings.
With the huge debt left behind by the Bush administration, the US should
be especially motivated to get the largest possible stimulation from
each dollar spent. The legacy of underinvestment in technology and
infrastructure, and the growing divide between the rich and the poor,
requires congruence between short-run spending and a long-term vision.
That necessitates restructuring tax and expenditure programmes. Lowering
taxes on the poor and raising unemployment benefits while simultaneously
increasing taxes on the rich can stimulate the economy, reduce the
deficit and reduce inequality. Cutting expenditure on the Iraq war and
increasing expenditure on education can simultaneously increase output
in the short and long run and reduce the deficit.
Keynes was worried about a liquidity trap — the inability of monetary
authorities to induce an increase in the supply of credit in order to
raise the level of economic activity. US Federal Reserve chairman Ben
Bernanke has tried hard to avoid having the blame fall on the Fed for
deepening this downturn in the way that it is blamed for the Great
Depression. And yet one should read history and theory carefully:
preserving financial institutions is not an end in itself, but a means
to an end. It is the flow of credit that is important, and the reason
that the failure of banks during the Great Depression was important is
that they were involved in determining creditworthiness.
But America’s financial system has changed dramatically since the 1930s.
Many of America’s big banks moved out of the “lending” business and into
the “moving” business . They focused on buying assets, repackaging them
and selling them, while establishing a record of incompetence in
assessing risk and screening for creditworthiness. Hundreds of billions
have been spent to preserve these dysfunctional institutions. With
private rewards so markedly different from social returns, it is no
surprise that the pursuit of self-interest led to such socially
destructive consequences. Meanwhile, too little is being done to help
banks that actually do what banks are supposed to do — lend money and
assess creditworthiness.
The US government has assumed trillions of dollars of liabilities and
risks. In rescuing the financial system, no less than in fiscal policy,
we need to worry about the “bang for the buck”. Otherwise, the deficit
will soar even more.
In September, there was talk that the government would get back its
money, with interest. As the bail-out has ballooned, it is increasingly
clear that this was merely another example of financial markets
misappraising risk. The terms of the bail-outs were disadvantageous to
taxpayers, and yet remarkably, despite their size, have done little to
rekindle lending.
The neoliberal push for deregulation served some interests well.
Financial markets did well through capital market liberalisation.
Enabling the US to sell its risky financial products and engage in
speculation all over the world may have served its firms well, even if
they imposed large costs on others.
Today, the risk is that the new Keynesian doctrines will be used and
abused to serve some of the same interests. Have those who pushed
deregulation 10 years ago learned their lesson? Or will they simply push
for cosmetic reforms? Has there been a change of heart, or only a change
in strategy?
Ten years ago, at the time of the Asian financial crisis, there was much
discussion of the need to reform the global financial architecture.
Little was done. It is critical that we not just respond adequately to
the current crisis, but that we undertake the long-run reforms that will
be necessary if we are to create a more stable, prosperous and equitable
global economy. ©Project Syndicate, 2008. www.project-syndicate.org
# Stiglitz is professor of economics at Columbia University and
recipient of the 2001 Nobel Prize in Economics.
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