At this year’s Labour Party Conference Policy Exchange will be hosting a discussion that will examine the scope for an alternative economic policy, along with the constraints and practical obstacles it may encounter. In the months ahead Policy Exchange will be looking at the big contemporary questions in fiscal policy, monetary policy and the structure of the financial system following the Great Recession. We shall examine the legacy and modern relevance of John Maynard Keynes.
The questions that occupied economists when the Left of the Labour Party struggled in the 1970s to construct an intellectually coherent alternative economic strategy have returned. Jeremy Corbyn’s election as Leader of the Labour Party and the opportunities presented by Brexit in terms of discretion over trade and state aid rules have transformed the potential policy landscape. Today central banks are debating the limits of monetary policy and the potential revival of an active role for fiscal policy. This debate is not confined to Britain or America. It is the central debate among policy makers in every major economy from China, India and Japan to the euro-zone.
This year is the eightieth anniversary of the publication of Maynard Keynes’s General Theory in 1936. Keynes provoked a revolution in economic policy. At its heart was active demand management to stabilise the economic cycle, using fiscal policy and the government’s budget balance, taking the view that monetary policy was less powerful or ‘passive’ and directing the central bank to keep interest rates low to stimulate investment. This October 2016 also marks the fortieth anniversary when the post-war Keynesian consensus was abandoned. The Keynesian system gradually became unstable in the 1960s and ultimately collapsed in 1976 when James Callaghan in a powerful speech, drafted by his son in law Mr Peter Jay the economics editor of The Times, abandoned it at the Labour Party Conference.
Britain’s Economic Counter-Reformation
The counter-reformation in British macro-economic policy that followed the dumping of the Keynesian framework in 1976 resulted in a practical policy consensus. It gave primacy to price stability, achieved through managing monetary conditions, ended the active role of fiscal policy and emphasised the need to improve the structural performance of the supply side. Governments retreated from active industrial intervention, state support for infant industries and regional economies and from any suggestion of picking winners. EU policy expressly limited state aid to industry.
The Alternative Economic Strategy – Keynes’s Closed Economy and the Balance of Payments
Not everyone accepted the dumping of Keynesianism. In the 1970s and early 1980s the authors of the Alternative Economic Strategy concentrated on facilitating a neo-Keynesian fiscal stimulus that would be made practicable and effective by protecting the UK’s vulnerable balance of payments. In many respects it represented an attempt to address the lacuna at the heart of Lord Keynes’s General Theory from a practical policy making perspective. The General Theory offered an analysis of demand in a closed economy that would be difficult to follow in an open economy integrated into world trade.
The New Cambridge Approach
With a balance of payments deficit of almost 7 per cent of GDP, the current account again represents a practical constraint on modern UK policy. Part of the intellectual ferment that stimulated the Alternative Economic Strategy of the 1970s and the early 1980s was the theoretical work pursued by Professor Wynne Godley and Dr Francis Cripps in Cambridge. New Cambridge provided a critique of the British version of the Keynesian consensus. Much of the debate generated by New Cambridge was recondite, concerning the stability of the private sector’s accumulation of financial assets, and the role of the budget and fiscal policy in stabilising the balance of payments. Wynne Godley broke with the standard establishment assumptions of the Treasury and the Bank of England at time. It was intellectually novel and provocative. It recognised that an ambitious fiscal stimulus would be vitiated by the vulnerability of the balance of payments.
The economic strategy that flowed from this united a policy agenda to square full employment and sustained economic growth with a balance of payments protected from imports, if necessary, by controls. The principal difficulty of the programme was the threat of retaliation from the UK’s trading partners and the UK’s dependency on imports of technology that would be critical for the modernisation of what was already a rapidly deindustrialising economy.
Looking again at the role of the Exchange Rate
Other economists and intellectuals on the British left proposed a lower exchange rate. Among them were Bryan Gould and John Mills arguing that much of the necessary stimulus could be generated by a lower exchange rate that would both stimulate growth and protect the balance of payments, without the potential distortions that would arise from controls on trade and the potential friction with foreign trading partners. John Mills, who is joining our discussion, has recently published a book with Roger Bootle The Real Sterling Crisis exploring again many of his ideas.
Who needs economic radicals on the Left when you have Central Banks that use Cargo planes, forget Helicopters?
Since 2007 the world has been turned upside down. Deflation has replaced inflation as a challenge. Banks became insolvent and were rescued by a combination of nationalisation and central bank infusions of liquidity supported by taxpayers. Central banks are coming to the conclusion that they may have run out of road. They emphasise structural reform and are increasingly thinking that active fiscal policies may be needed to stabilise the economy. The Bank of Japan has just announced that it will stabilise ten year government bond yields in the way that the Federal Reserve repressed interest rated in the 1940s. Future economic historians may well ask whether contemporary policy makers have already abandoned the orthodoxy of the last forty years. Given the expansion of G7 central bank balance sheets, the scale of liquidity and level of asset prices the metaphor of helicopter money might more accurately replaced by that of fleet of heavy pay load cargo planes.