by Mario Rizzo
There has been a great deal of discussion about stimulus as a cure for recession and incipient depression. Let’s now look ahead a bit.
When is it time to start worrying about inflation? Not according to Ben Bernanke or me, but according to John Maynard Keynes.
We can look at Keynes’s 1937 trio of articles for The Times of London, “How to Avoid a Slump.”
Apparently the time to start worrying is at the first signs of recovery, and not when the level of unemployment and output (or output growth) has returned to “normal.”
In 1937 the unemployment rate in Britain was still high but it had been falling significantly for about a year. Industry was picking up in London but it was still in poor shape through much of the country. Yet Keynes thought it was now time to worry about inflation.
What did he propose to do? Interest rates should not be raised – this was against Keynes’s idea that they should be kept permanently low. No counter-cyclical policy with respect to the interest rate. (Keynes wanted to avoid inflationary pressures without causing a relapse into a depression.)
“A low enough long-term rate of interest cannot be achieved if we allow it to be believed that better terms will be obtainable from time to time by those who keep their resources liquid. The long-term rate of interest must be kept continuously as near as possible to what we believe to be the long-term optimum. It is not suitable to be used as a short-period weapon.”
What he did propose is that special targeted measures be undertaken to stimulate the depressed areas directly. He believed that public works in the home counties (those around London) were not enough to bring stimulus to the depressed areas (northern and western England, including Wales) What we need now, he said, is not more stimulus in general but more appropriately distributed stimulus. “We are in more need to-day of a rightly distributed demand than of a greater aggregate demand…”
Furthermore, in view of the incipient general recovery – even at 10% national unemployment (but much higher unemployment rates in many areas) – “the Treasury would be entitled to economize elsewhere to compensate for the cost of special assistance to the distressed areas.”
Thus, the first thing to keep in mind is that Keynes departed somewhat from his aggregate analysis to look more carefully at the distribution of employment and output recovery across geographic areas (and implicitly across sectors of the economy).
Secondly, he advocated – in the later stages of recovery – targeted stimulus. Implicitly he assumed that all areas should recover – that there should not be any significant re-allocation of resources across areas. To my mind this is something like industrial policy. People had been leaving the North and West for some time, even before the Depression, as industry declined there.
Thirdly, although his general policy recommendation was more or less to maintain, not increase, the current level of aggregate demand, he advocated more specifically:
1. Cutting back expenditure elsewhere for increased relief of the distressed areas.
2. Paying for the current and future re-armament of Britain primarily with taxation and not loan expenditure (deficits).
3. Local authorities holding back on new investment projects at this time. “Just as it was advisable for local authorities to press on with capital expenditure during the slump, so it is now advisable that they should postpone whatever new enterprises can be reasonably held back.” Keynes also seems to suggest that now is “the right time for procrastination at the Ministry of Health.” [Imagine that! MR.]
But they should also have detailed plans in reserve for expansion at the appropriate time if a new slump threatened (“shovel-ready” projects). “Recent experience has shown us how long it takes to prepare for useful investment…”
4. Granting a temporary rebate of tariffs to encourage imports so as to “help to relieve a temporarily inflated demand in the home market.”
This look into the cautious side of Keynes’s policy ideas suggests a problem. Does our government – the political branches and the Fed – have the will to follow Keynes in his caution? Will it start worrying about inflation early in the process of recovery? If our history is a guide, then the answer is no. It takes no political courage to spend; it does take political courage to stop.
Let’s see if the behavioral economists in the Administration can figure out a way to nudge the partygoers into sobriety.