Keynes Reborn – Koichi Hamasaki. 

Large public debts are not always bad for an economy, just as efforts to rein them in are not always beneficial.

The focus on a balanced budget in the United States, for example, has led some elements of the Republican Party to block normal functions of state and even federal authorities, supposedly in the name of fiscal discipline. Likewise, the eurozone’s recovery from the 2008 financial crisis has been held back by strict fiscal rules that limit member countries’ fiscal deficits to 3% of GDP.

Contrary to popular belief, aggregate demand and the price level (inflation) are not dictated only – or even primarily – by monetary policy. Instead, they are determined by the country’s net wealth and the liabilities of the central bank and the government.

When government deficits are lower, investing in government debt becomes more attractive. As the private sector purchases more of that debt, demand for goods and services falls, creating deflationary pressure. If the central bank attempts to spur inflation by expanding its own balance sheet through monetary expansion and by lowering interest rates, it will cause the budget deficit to fall further, reinforcing the cycle. In such a context monetary policy alone would not be adequate to raise inflation; fiscal policy that increases the budget deficit would also be necessary.

John Maynard Keynes’ The General Theory of Employment, Interest, and Moneywhich argued for active fiscal policies, was published in 1936. Forty years later, a counterrevolution took hold, reflecting sharp criticism of fiscal activism. After another 40 years, Keynes’ key idea is back, in the form of the FTPL (fiscal theory of the price level). This may be old wine in a new bottle, but old wine often rewards those who are willing to taste it.

Project Syndicate 

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