Politicians often cite John Maynard Keynes and exploit his theories in order to justify spending, especially during a recession. The theory says that economic output of a country is a function of total spending, therefore countries can alleviate crisis by increasing expenditures with public money, among other things, especially targeted to drive unemployment down, the best way of increasing markets demand.
Better if it can be supported by low central bank rates. Such a policy creates debt, among other side effects. These days such a policy takes the name of Quantitative Easing (QE).
More spending does not always work that easily
However, a few other conditions are necessary in order for country in question to exploit that “largesse” and to maintain a long-term stability:
- There as to be a favorable ground, i.e., low level of corruption, for instance, as to avoid that the money get pocketed by few and vastly misused. Moreover, if a country has a too high level of debt, trust that it will be repaid is low and the money could find its way abroad.
- The banking system must be robust and relatively efficient; of course, it must also be incentivized to lend to the economic actors.
- A Keynes key principle was the one of a balanced budget over the medium term, which entails the need of reducing spending during boom times: this is often “forgotten” by politicians who view this as a clear receipt for not being reelected and lose their job. It is much easier to justify spending and cuts, which make someone of some categories of people inevitably lose out. This point is somewhat connected with the previous one, whereby less corrupted countries find it easier to run a balanced budget.
And in case of an economic depression?
There’s another issue to be considered: the recession must be over before the debt runs out of control. If we are facing a deep and prolonged recession or a depression the risk of losing credibility and head towards default is real. Having a balanced budget and strong finances before a bust strikes is therefore a fundamental condition. Unfortunately such an exercise is quite hard in the developed economies which have an aging population and face the problem of having to finance an increasing amount of welfare costs. Most of them are finding creative ways to reduce such expenses by increasing the retiring age, reducing benefits, etc. But that’s another chapter.
One may say: if you have good finances and you act swiftly during a recession then a depression won’t even happen. That could have been true when the world was not so connected and globalized. Instead these days you are not safe anywhere, the amount of money circulating and the macroeconomic forces can well be beyond what any country alone can afford to control.
- Franco Prati