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Decimal Digest
03 Dec 2012

Time to bury Keynesian Thinking?

“Some have tried, and all have failed” – Woody Allen in the movie “To Rome with Love

Every now and then, we come across respected economist and politicians of all shades commenting that the austerity is compounding the misery of peripheral and soft core Europe. The key question is how can one be certain that reversal of austerity can lead to prosperity.

Although it is true that in the field of Macroeconomics one cannot conduct controlled experiments, one can surely learn from actual experience in other economies, which have tried similar policies.

The chart below shows the structural general government deficit numbers estimated (and forecasted) for Japan for period 1995-2017.

Chart 1: Structural General Government Balance for Japan (% of potential GDP)

Source: IMF

The chart shows that during this 23-year period Japan run (or plans to have) structural imbalance of about 6% each year, and the general trend is for increasing structural deficit. We all know that Japan had very anemic growth during last one generation, in spite this huge fiscal stimulus, combined with ultra-loose monetary policy. This live experiment of unbridled Keynesian policy has failed to produce expected results in the face of strong headwinds of deteriorating demographics combined with over-extended banking sector and long-term currency appreciation.

Most of the western world is today facing the same head winds of demographic change and over-extended banking sector.

Additionally, when Mr. Keynes articulated efficacy of counter-cyclical government balances to tone down the impact of business cycles, the realm of government’s remit in commercial world was very limited (expect for USSR). Now, with Nanny Government being a norm is western world; marginal efficacy of additional government expansion will surely be subject to steep diseconomies of scale.

Maybe, it is time to rethink the prescriptions for management of amplitudes of economic cycles beyond something dictated by simple arithmetical equation of national income like Keynesian Pump Priming. It is entirely possible that a policy prescriptions hinging on improving medium-term flexibility and efficiency of economic operations, combined with redirection of Nanny State to more emphasis on learning at schools of western world focus on more relevant skills - so that even the bottom rung produced by those schools is employable in the world governed by AI, 3D Printing and Internet of Things - will produce positive effects for developed world in the medium and the long run.


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