tutor2u | Why Keynes argued there must be limits to government…

Topic updates

Why Keynes argued there must be limits to government borrowing.

Geoff Riley

24th June 2021

Paul Ormerod writes that "Keynes was a much more subtle economist than almost all his 21st century disciples."

The Treasury is making a massive effort to reassert its traditional role as guardian of the public finances.

It has already notched up one substantial victory. The education recovery tsar, Kevan Collins, was appointed in February to help pupils recover education missed during the Covid-19 pandemic. But he resigned earlier this month, after his apparent demand for £15 billion was beaten down to a mere one-tenth of that by the Treasury.

But the missiles seem to zoom in from all directions.

More precisely, they all emanate from Number 10 and each involves a spending commitment in a wide range of different areas. The Treasury is getting zapped across almost the entire area of government activity.

The Prime Minister wants a Marshall Plan to fund green growth in the developing world. He wants to spend huge amounts on the levelling up agenda. He appears to favour a scheme to cap care home costs which would require even greater amounts of money.

Does it actually matter? Why can’t it all be paid for by simply issuing more government debt?

Public sector net borrowing soared during the financial crisis to £160 billion in 2009. By the end of the last decade, the annual amount had been clawed back to under £50 billion. But the Covid crisis last year saw it rise to the entirely unprecedented peace time level of more than £250 billion.

Throughout the Western world governments have been running up similarly massive amounts of debt. But the markets appear to be taking this in their stride. Although yields on government bonds have risen slightly , they are still at historically low levels. Investors still seem willing to finance the debt.

There are two main problems with the policy of just letting spending to continue to rip, funded by more and more debt.

These were anticipated in the 1930s not by some zealous free-market economist, but by no less a figure than John Maynard Keynes himself.

The name of Keynes is linked in public perception to high public spending and government deficits.

True, Keynes did advocate these in the 1930s to combat the Great Depression and unemployment rates which soared well above 10 per cent in many Western countries.

But he was a much more subtle economist than almost all his 21st century disciples.

In his major work, The General Theory of Employment, he acknowledged there were two potentially serious drawbacks to the policy.

As full employment approached – and the UK is currently close to such a situation – Keynes argued that any further public spending would “set up a tendency for money prices to rise without limit”. In other words, inflation would become endemic.

Even more importantly, Keynes recognised that the attitudes of the markets to rising government debt was based on psychology rather than hard facts. In essence rising debt is fine. Until it is not. Perception is all. Once confidence is lost, interest rates can rise by large amounts very rapidly.

The Prime Minister is a gambler. But his current policies involve a huge gamble with both inflation and interest rates.

Geoff Riley

Geoff Riley FRSA has been teaching Economics for over thirty years. He has over twenty years experience as Head of Economics at leading schools. He writes extensively and is a contributor and presenter on CPD conferences in the UK and overseas.

Recommended

Exam support for 2022

Online Grade Booster Courses for A-Level Exams in May & June 2022

Exam technique, advance information support, live revision and more from the tutor2u subject specialist teams

Enrol now

© 2002-2022 Tutor2u Limited. Company Reg no: 04489574. VAT reg no 816865400.