Bring back Keynes

The best way out of the economic crisis is to cut interest rates, create jobs and raise incomes!

o Ann Pettifor
o The Guardian,
o Tuesday September 30 2008

Anglo-American finance ministers and central bankers, like little Dutch boys, try desperately to plug leaks in the bursting dyke that is the international financial system. In the US, treasury secretary Hank Paulson hoped for $700bn to plug the gaping hole in Wall Street's banks. In the UK, the government is not just plugging holes, but setting aside competition rules to encourage the monopolisation of finance. Alistair Darling suspended competition rules to allow the Lloyds Bank takeover of HBOS because of the crisis. This is like suspending the law during hurricanes. The demise of another independent bank, Bradford & Bingley, and the transfer of its savings business to Santander, will increasingly monopolise finance.

Will these plugs and private-sector fixes work? No, because

• they are not system-wide fixes and
• they are based on the same flawed economic policies that spurred this crisis in the first place.
  

Some of these policies, attributable to Friedrich Hayek and Milton Friedman, are already discredited. Contempt for government is no longer acceptable. Using fiscal policies to bail out banks is now sanctioned by all political parties. To refuse to use fiscal policies to bail out taxpayers who lose pensions, homes and jobs, will make political parties unelectable.

But there are other orthodox economic policies that remain intact and are as yet unchallenged by any political party. The most damaging is orthodox monetary policy. This is based on the assumption that money is a commodity, and that its "price" - the rate of interest - must be set by supply and demand for money in private markets for capital - just as the price of oil is set by supply and demand for oil.

This is a nonsense. We do not dig capital out of the ground, nor does it grow on trees. Money is man-made. Interest rates are a social construct. And as such, unlike oil or soya beans, "there are no intrinsic reasons for the scarcity of capital", as Keynes argued in the General Theory. Because there is no reason for the scarcity of capital, there is no reason for the price of capital to be high.

And yet the private finance sector has succeeded in creating a shortage of capital, the credit crunch, and - at the height of a debt crisis - ratchets its price ever upwards. The rate for private inter-bank loans (Libor) continues to move upwards as the crisis worsens.

The private finance sector also requires that central banks maintain official, or base rates at current levels by adhering to a policy esoterically named "inflation targeting". In fact these high rates, by making debts unpayable, lead to rapid de-leveraging of debts (think bank failures) and assets (think property price falls) and are dangerously deflationary.

Flawed monetary policies are turning a crisis into a catastrophe. They must be challenged. Keynes's cool, rational voice on monetary theory and monetary policy must once again be heeded. Central banks must once again take control over all rates - short and long, safe and risky.

But a system-wide fix would go further. It would challenge the orthodoxy that unemployment helps keep wages low and is a good thing; and that wage rises are always inflationary. It is this orthodoxy that has caused wages and other forms of compensation to fall as a share of GDP in all OECD countries over the past three decades. This fall in compensation has forced people to supplement incomes by borrowing more.

Creating jobs and raising incomes as a share of GDP is vital if we want people to repay debts, salvage banks and return to the high street. If we fail to adopt such system-wide fixes, and if we persist with economic orthodoxy, then look forward to a prolonged period of global economic failure.