Sometimes history is written by the losers

A good post on the notion of “hard Keynesianism” raises some important questions about the recent past of the Labour Party. Hard Keynesianism is the doctrine that, if the government should run a deficit when there’s a negative output-gap and therefore unemployment, it should run a surplus when there’s a positive output-gap and therefore inflation.

It’s trivially true that the government can’t increase its indebtedness as a share of the economy forever, so obviously if you do any fiscal stimulus at all you need to think about a budget consolidation some time in the future. But the hardness in the hard Keynesianism comes from the idea that the average balance of the government budget ought to be zero. That is to say, between recessions the government should always be running a surplus, and it should just unwind that to deliver stimulus.

There are several problems with this idea. First of all, getting to the point of running a semi-permanent budget surplus is an enormous job and we ought to be very sure it’s a good thing before undertaking it, especially as it involves offering everyone whacking tax rises.

Secondly, big private companies or nationalised industries don’t usually target zero net debt just for the sake of it. After all, if you can get a return on investment higher than the cost of capital, i.e. the interest rate you pay, you ought to raise the capital and invest it. In so far as this doesn’t happen, running the public sector as a structural saver might cost us all in terms of economic growth. It’s not obvious that major infrastructure projects should wait until a recession comes along and gives us an excuse to build.

Thirdly, a permanently reducing supply of government bonds might have unforeseeable consequences in the financial sector. Pension funds are big buyers of government debt because it’s considered relatively safe and it’s available in different maturities, so they can match the flow of income from it to the expected flow of pensions. If it was in short supply, they’d have to pay much more for it, and as a result, pension rates would be worse. Banks park their spare cash in government securities. The Bank of England trades them in order to manage the interest rate. We don’t really know what would happen here.

But finance could react to a shortage of AAA-rated bonds in a couple of ways. One would be to push money into riskier investments. That might in fact help the economy, by getting more money into industry, but you try telling that to people whose savings vanished. Another would be to do what they’re doing now, which is just to sit on their cash and do nothing, so we have a demand-deficient recession. A third would be to do what they did a couple of years ago, and invent new AAA assets. And look how that turned out!

And fourthly, we’d have to think hard about what to do with the surplus money. We couldn’t risk it, and it would have to be liquid so as to be available in a crisis. Obviously, foreign government bonds…you see where I’m going here.

Now, as far as I can see, the main attraction of hard Keynesianism in Britain is either that it sounds easy to sell because it uses the rhetoric of tough-osity, or else that it’s something to throw at Gordon Brown. After all, there is little point complaining about surging public spending in the mid-2000s – because public spending didn’t actually surge in the mid-2000s – or that we can’t plan on expanding the public sector as a percentage of GDP – because it wasn’t historically big or fast-growing in the mid-2000s.

So if your aim is to support the Blairite king-over-the-water, and you’re not willing to simply pretend that there was a public spending blowout in 2005-2006, you need an alternative and hard Keynesianism is it. Oddly, if you take into account some of my objections, you end up with something rather like Gordon Brown’s fiscal rules.