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Flat-earth economists lead the hysteria over budget deficits

An excellent summary of what is wrong with our approach to economics by Beth Webster
Back in the good old days of the 19th century when market economies oscillated between boom and prolonged recession, economists believed that nations were like households. They had to balance their budgets. If they spent more in one year they would have to save more the next to pay off the debt. Sound advice for a household. But not so for an economy as a whole.

Welcome to the Keynesian revolution

Keynes proved this in 1936, and subsequently governments followed this theory to get their economies out of depression and onto the long economic boom that lasted until the mid-1970s.

Downward spiral

What stops this downward spiral? There needs to be an external injection of spending into the system. This is the essential Keynesian message. By external, we mean something that does not originate from employees (householders) or the investment community. It has to come from either the government in the form of perpetual budget deficits or perpetual exports.

Exports are not the answer At the end of the day, the stimulus to incomes has to come from governments who control the money supply and can thus spend without having to borrow. Essentially, they can monetise the debt. They do not have to pay this debt back – it is spending financed by central banks. The point is that if the government adds to spending (and production) without extracting an income for itself, it allows investors to realise the minimum rate of profit necessary for them to invest again.

This is what occurred for the 25 years following WWII. So what stopped it?


Inflation. Inflation instigated by a series of oil price shocks but then prolonged by excessive government spending in the US to finance the Vietnam war. Governments in the late 1970s and 1980s reacted to inflation by drastically cutting spending. But the rate of inflation did not fall until the price of oil fell in the 1990s and China flooded the world with cheap manufactured goods. Certainly, if an expansion of the money supply is excessive we will get inflation. But taken to an extreme in the other direction, we get low growth and unemployment.

Where do you think we are in 2016? With 700,000 official unemployed, close to another 700,000 under-employed, and an inflation rate below 2%, I would say we are swung too far to the parsimonious side. It is all about balance. It should not be about blind and mechanical fear mongering about government budget deficits. The current political debate is on level with a Tony-Abbott-climate-change debate. Misguided, low brow and damaging to the well-being of many people.


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