Imagine this. In late 1936, shortly after the publication of his classic General Theory, John Maynard Keynes is cryogenically frozen so he can return 80 years later.
Things were looking grim when Keynes went into cold storage. The Spanish civil war had just begun, Stalin’s purges were in full swing, and Hitler had flouted the Treaty of Versailles by remilitarising the Rhineland. The recovery from the Great Depression was fragile. It was the year of the Jarrow march and Franklin Roosevelt’s second presidential election victory.
Waking up in 2016, Keynes wants to know what’s happened in the past eight decades. He’s told that the mass unemployment of the 1930s finally came to an end but only because military production was ramped up by the great powers as they came to blows for the second time in a quarter of a century.
The good news, Keynes hears, is that lessons were learned from the 1930s. Governments committed themselves to maintaining demand at a high enough level to secure full employment. They recycled the tax revenues that accrued from robust growth into higher spending on public infrastructure. They took steps to ensure that there was a narrowing of the gap between rich and poor.
The bad news was that the lessons were eventually forgotten. The period between FDR’s second win and Donald Trump’s arrival in the White House can be divided into two halves: the 40 years up until 1976 and the 40 years since.
Keynes discovers that governments deviate from his ideas. Instead of running budget surpluses in the good times and deficits in the bad times, they run deficits all the time. They fail to draw the proper distinction between day-to-day spending and investment. In Britain, December 1976 was the pivotal moment. Matters came to a head in early December when a divided and fractious cabinet agreed that austerity was a price that had to be paid for a loan from the International Monetary Fund, which was needed to prop up the crashing pound.
Subsequently, Keynes is informed, there was a paradigm shift. Labour had been reluctant converts to monetarism; the Thatcherites who followed were true believers. Controls on capital were lifted, full employment was abandoned as the prime policy goal, trade union power was curbed, taxes for the better off were cut, inequality was allowed to widen, finance waxed as manufacturing waned.
You don’t need to go on, Keynes says, because I can tell you what happened next. Bashing organised labour and cutting government spending led to a dearth of effective demand that was papered over by cuts in interest rates. Cheaper money led to some increase in productive investment but this was overshadowed by speculation in the stock market and real estate. Eventually, the bubble burst and – just as in 1929 – there was a stupendous crash.
That explains why the headlines I can see from 2016 bear so much resemblance to those from 1936: high unemployment and a lack of growth that has bred deep public resentment. That explains the referendum results in the UK and Italy, the outcome of the US presidential election and the growing support for far-right parties in Germany and France.
Even so, Keynes is surprised to discover that the crash occurred, not in 2016 or 2015, but some eight years earlier. What’s been happening in the meantime, he asks?
The answer given is that initially central banks slashed official interest rates to levels never seen before. In the UK, borrowing costs were were reduced to 0.5%, even lower than the trough of 2% reached after the pound came off the Gold Standard in 1931.
But that was not all. Central banks also bought bonds from private institutions, with the aim of increasing the supply of money and reducing market – or so-called long-term – interest rates. Both initiatives meet with Keynes’s approval. His works advised the use of aggressive monetary policy because lower interest rates should help to stimulate higher private sector investment, because in most cases this is what lifts economies out of recession.
But, he adds, if this was a really serious slump then monetary policy might not have been enough on its own. In certain circumstances, it doesn’t really matter how low interest rates go – private companies feel so uncertain about the future they are reluctant to invest. People hoard cash rather than spend it. Monetary policy becomes like the drug soma in my friend Aldous Huxley’s book Brave New World – it calms people down and disguises the fact that something untoward is happening.
Keynes is told that ever bigger doses of monetary soma have been necessary to keep the global economy ticking over, with weak investment leading to poor productivity and growth rates well below those seen in the years leading up to the crisis. He asks the obvious question – if monetary policy has ceased to be effective, what have governments been doing to help?
It is an obvious point to raise. His General Theory says that the desire of the private sector to invest is affected by “animal spirits”. When animal spirits are low, governments should step in with public investment. They should do this even at the cost of a higher budget deficit, because the higher growth that will result will mean the investment more than pays for itself.
He is aghast to hear that apart from during a brief period of collective stimulus in 2009, this approach has not been followed. Governments quickly grew concerned about the size of their budget deficits and cut public investment.
But weak growth meant deficit reduction took longer than expected. Ultra-low interest rates for the best part of a decade have led to asset-price bubbles. Measures of private indebtedness are rising again. All depressingly predictable, Keynes says. Time to return to 1936.
Before you go, he is asked, what advice do you have for policymakers in 2016. Keynes outlines three alternatives to the status quo. The tax-cutting and infrastructure spending plan proposed by Trump will lead to stronger growth in the short term, but Keynes says he is not especially impressed. He fears that there will be little extra investment in the public infrastructure that the US actually needs and that the stimulus will be poorly focused.
The second option would be to exploit exceptionally low interest rates by borrowing for long-term investment projects. Governments could do this without alarming the markets, Keynes says, if they followed his teachings and borrowed solely to invest.
Option number three would involve being more creative with quantitative easing, Keynes says. Instead of the newly created money being used for speculative plays, why shouldn’t governments use it to finance infrastructure? Building homes with QE makes sense; inflating house prices with QE does not.
There is, he adds, another escape route. We were building up to it in 1936 and it arrived three years later. Not recommended.
• This article was amended on 12 December 2016. Hitler remilitarised the Rhineland in 1936, not the Sudetenland as a previous version said.
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