Keynes versus the IMF

This was published in Express Tribune Opinion Pages on March 16th, 2015 —Keynes vs IMF. It is placed in the Pakistani context, but the same issues are relevant for Greece, Spain and Ireland.

Leading economists like Keynes and Fisher had forecast prolonged prosperity, just prior to the Great Depression of 1929. The shock of the Great Depression led Keynes to create Keynesian Economics. According to conventional economic theory, increasing the quantity of money in circulation has only one effect: increasing the level of prices. That is, printing money is inflationary, and has no effects on the real economy. Many economists of the time noted that massive bank failures had led to substantial reduction in the money supply. They came to a realization that these events were related. Contrary the classical theory that money only effects prices, the shortfall in the money supply caused the massive unemployment of labor and other factors of production and the contraction of the GNP.

Keynesian theory is based on a very simple idea that conduct of the ordinary business of an economy requires a certain amount of money. If the amount of money is less than this amount, then businesses cannot function – they cannot buy inputs, pay laborers or rent shops. This was the fundamental cause of the Great Depression. The solution was simple: increase the supply of money. Keynes suggested that we could print up money and bury it in coal mines and have unemployed workers dig it up. If money was available in sufficient quantities, businesses would revive, and the unemployed laborers would find work. By now, there is nearly universal consensus on this idea. Even Milton Friedman, the leader of Monetarist School of Economics and arch-enemy of Keynesian ideas, agreed that reduction in money supply was the cause of the Great Depression. Instead of burying it in mines, he suggested that money could be dropped from helicopters to solve the problem of unemployment.

But what about inflation? Isn’t it true that printing money in massive quantities would lead to inflation? According to Keynesian theories, this would happen after full employment was achieved. That is, once the economy reached its maximum production capabilities, further money could not contribute to an increase in production. At this point, printing more money would only lead to inflation, exactly as the classic economic theory predicts. Keynesian theory gives the Central Banks of the worlds an extremely important task: maintaining the money supply at exactly the right level to create maximum production without running the risk of inflation. Keynes also said that monetary policy may be insufficient for the task, and the government had direct responsibility to ensure full employment using fiscal policies.

Regulation of financial markets, social support for the poor, and government responsibility to provide jobs for all led to decades of prosperity in Western economies. The share in the wealth of the bottom 90% increased, while the share of the top 0.1% decreased. This state of affairs did not please the wealthy elites, who launched an extremely successful attack against Keynesian ideas in the 1970s. The Arab oil embargo led a sharp rise in oil prices and inflation, while simultaneously disruptingdisrupting productive activities and creating unemployment. Keynesian theories state that we can only have one or the other; “stagflation” or simultaneous presence of high inflation and high unemployment is ruled out.

This weakness in Keynesian theory was successfully exploited by the rich and powerful to argue that the main problem lay with government interventions. Reagan dismantled some of the post-Depression regulations which limited the powers of the wealthy financiers, as well as the social support and unions which strengthened the labor class against them. In particular, with great fanfare, Reagan de-regulated the Savings and Loan (S&L) Industry. Exactly as in the Great Depression, the banks took advantage of this to speculate in risky investment with the depositors’ money, and lost billions of dollars, creating a nation-wide banking crisis. However, the government had learnt its lessons from the Great Depression, and did a massive bailout to prevent a financial crisis entailed by the collapse of the S&LsL. Over the next few decades, deregulation unleashed the power of the financiers, and cuts in social services weakened the labor class, with predictable results. Speculative financiers gambled heavily with the money of others deposited in banks, leading to myriad monetary crises. At the same time the labor class was squeezed, resulting in rising inequalities and massive concentration of wealth at the top.

In the post-Keynesian era, the clarity of Keynes has been lost. Many Central Banks have gone back to pre-Keynesian ideas, abandoning the goal of full-employment, and focusing solely on controlling inflation. Substantial doubt has been created as to whether or not monetary policy, or helicopter money, can be useful in solving problems of unemployment. When countries spend more foreign exchange on imports than they can earn, they are forced to borrow dollars from the IMF. As a condition of such loans, the IMF insists on austerity – governments should balance budgets and not print money to finance deficits. According to the IMF, financing deficits with increases in money supply can lead to high inflation, with heavy economic costs. However, according to Keynes, we should increase money supply in an economy with high unemployment such as Pakistan. Printing money is not inflationary in such a situation. So who is right? Keynes or the IMF?

Recent research by Princeton economists Mian and Sufi sheds considerable light on the answer, which is obvious in retrospect: Both Keynes and IMF are right. What happens depends on who picks up the helicopter money and what they do with it. If those who get the money buy land, property values will go up. If they invest in stocks, this will create a bubble in the stock market. If they put it in their Swiss accounts, this will lead to depreciation of the exchange rate. However, if the money is used wisely, to invest in projects which increase the productive capacity of the economy, this will create employment and generate the economic returns needed to provide support and backing for the newly created money.

When Keynesian policies of full employment and social support for laborers eroded the wealth shares of the power of the rich, it is an article of faith for the wealthy elite, the counterattack created alternative policies, as well as theories and ideologies to support these policies. Decades of experience with these policies, codified in the Washington Consensus as privatization, liberalization and stabilization, has shown that they produce increasing inequality but do not produce growth. Alternative models for successful development are always corrupt. The historical record does not bear this out.available. The most spectacular recent example was labor leader Lula of Brazil. After being elected president in 2003, his deficit financed programs of social support and investment created progress and prosperity. Under Lula, Brazil went from being the most heavily indebted country in the world to the eighth largest economy, and 20 million people rose out of poverty. There are many other examples of wise public spending listed by Ellen Brown in The Public Bank Solution: From Austerity to Prosperity. Other kinds of examples also exist, where reckless and corrupt governments can wreak havoc on the economy, as the IMF fears. Can we rise to the challenge which faces us in Pakistan? That is, to curb corruption and spend efficiently on social services and productive investments, leading to the Keynesiian outdcomes of full employument wiithoujt inflation?

  1. Macrocompassion said:

    In this explanation of governmental activity to ease economic crises the writer gives us two alternative policies and compares their influences on the possibility for prosperity. He places the cause of these crises on the money policy of the government, which could be made to adopt either the release of more money for relief of unemployment or an austerity program with raised taxation of incomes, when some of the national debt is returned and the associated rate of interest is kept low. However he does not mention any other kind of national policy which might help.

    It is only fair to the would-be national managers that other considerations be included. So I wish to suggest that the facts as described above, which led to the 2007 crisis, are incomplete and heavily biased towards the money side of the macroeconomics. The fact that these bubbles are a regular feature of our social system and that they are associated with the cost of vacant land has not been mentioned, yet as long ago as 1879 Henry George claimed in his seminal book “Progress and Poverty” that the unstable nature of speculation in land values was the cause which starts the money cycle. The process is like this:
    a) Planners in local government corruptly leak information about where the next development is going to take place.
    b) Potential land owners, with the cooperation of the banks who feel that they cannot loose in lending for land purchases, start to buy up vacant sites.
    c) The scarcity of available sites for both house-building and community, drives up the price which encourages the first speculators to sell to later speculators who continue to hold the land unused. The banks transfer more and more of their power for creating debt into land. The rising prices of real estate give many people the impression of “good times” which encourages more speculation.
    d) When the costs of land reach a level which no longer makes the building of houses worthwhile, a crisis is reached and the unemployment in the building industry (which is dependent on materials, services and labor from many sources) ceases to operate properly.
    e) The banks wake up to the fact that many of their mortgages are becoming toxic and scramble to unload them and to reclaim their unstable investments. This is when the bubble bursts and government help to bail out the worst offenders is introduced.

    Such a process was described by Henry George–its nothing new. The money aspects are very significant but they are not the cause of this disaster. Land speculation is.

    The cure for this unstable action by the speculators (which some people mistakenly think of as capitalists) is for the government to make speculation in land values no longer worthwhile. They can do this by introducing laws to tax land values regardless of whether the site is in use or not. Many other kinds of taxation would be unnecessary and would be abandoned. This solution, know as by George as the single tax, would lead to a stable macro-economy with greater prosperity because the land would be used in a more efficient way.

    The advantages and disadvantages of Land Value Taxation (LVT) are given in my following comment.

  2. Macrocompassion said:

    15 ASPECTS of LAND-VALUE TAXATION affecting Government, Land Owners, Community and Ethics

    3 aspects for GOVERNMENT

    1. LVT, adds to the national income. Its introduction must be gradual but steady over about 8 years.
    2. The cost of collecting the LVT is much smaller than for income tax and other production-related taxes.
    3. With LVT, the national economy stabilizes and no longer experiences the 18 year housing boom and bust cycle.

    6 aspects affecting LAND OWNERS

    4. LVT is progressive, the owners of the most potentially productive sites pay the most tax.
    5. The land owner pays his LVT regardless of how the land is used. When the land is leased to tenants most or all of the resulting ground-rent is the tax, after full LVT has been reached.
    6. LVT stops the speculation in land prices because any withholding of land from proper use is too costly for land owners.
    7. The introduction of LVT reduces the sales price of sites even though their value (or potential usefulness) may continue to grow.
    8. With LVT, land owners are unable to pass the tax on to their tenant renters, due to the competition for land use.
    9. With the introduction of LVT, land prices will drop. Speculators in land values will tend to foreclose on their mortgages and to withdraw their money for reinvestment. Therefore LVT should be introduced gradually. It allows investors sufficient time to transfer money to company-shares where their greater use will meet the increased demand for produce (see below).

    3 aspects regarding our COMMUNITY

    10. With LVT, there is an incentive to use land for production, rather than it laying idle or being partly used.
    11. With LVT, greater working opportunities exist due to cheaper land and a greater number of available sites. Consumer goods become cheaper because entrepreneurs have less difficulty in starting-up and running their businesses. Demand grows, unemployment decreases and poverty ceases to be a significant social matter.
    12. As LVT is introduced, investment money is withdrawn from land and placed in durable capital goods.

    3 aspects about ETHICS

    13. The collection of taxes directly from productive effort and commerce is socially unjust. LVT replaces this form of extortion by gathering the surplus rental income which comes without exertion. Consequently LVT is a natural system of money-gathering.
    14. Bribery and corruption cease with LVT. Before, this was due to the leaking of news of municipal plans for housing development, etc.
    15. Due the more sensible use of land near to centers of population, city sprawl is lessened and the associated environmental damage is reduced.

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