By Anatole Kaletsky
NEW YORK, Oct 11 (Reuters) - John Maynard Keynes said backin 1936 that "practical men, who believe themselves to be quiteexempt from any intellectual influence, are usually the slavesof some defunct economist."
Keynes himself is now a seemingly defunct economist, but hisinfluence connects the two most important events of the week andperhaps of the year: the sudden reversal of fortunes in the U.S.election and the powerful critique of overzealous fiscalausterity produced by the International Monetary Fund.
What connects these two events is an economic question thatalmost nobody dares to raise publicly, but that now seemsdestined to dominate the U.S. election and that hung over theIMF annual meeting in Tokyo this week: Do deficits reallymatter? Or, to restate the issue more precisely: Are governmentefforts to cut budget deficits counterproductive in conditionsof zero interest rates when fiscal austerity suppresses economicgrowth?
This conclusion is strongly suggested by the IMF's "WorldEconomic Outlook" produced for the annual meeting. The WEOpresented six detailed case studies, starting with Britain from1918 to 1939, of economies that tried to reduce large publicdebt burdens with various policy mixes in the past 80 years.
It concluded that two conditions were essential for success:very low interest rates and adequate rates of economic growth.If fiscal austerity produces high unemployment and economicstagnation, it is doomed to failure, causing the government'sdebt burden to go up instead of down. After examining thishistorical evidence, the IMF report hinted strongly that atleast two major economies were now caught in self-defeating debtspirals: Spain, where the debt trap is created by politicalpressures from the euro zone, and Britain, where the futileausterity is entirely self-imposed.
The British example is particularly striking. While theBritish government has implemented bigger tax increases andspending cuts than any other major economy apart from Spain(equivalent to 4.3 percent of GDP since 2009), it has suffered adouble-dip recession, missed all its fiscal targets and seen itsnational debt nearly double from 46 percent to 84 percent of GDPsince 2009.
Meanwhile, the U.S., which started with a bigger deficit anddebt than Britain in 2009 and has made very little effort totighten fiscal policy since then, has seen its net national debtgrow considerably more slowly, from 54 percent to 84 percent ofGDP. The better U.S. fiscal performance, despite far less fiscal"effort," has been due entirely to faster economic growth.
Which brings me to the presidential debate last week. MittRomney won the debate largely by denying that his plan for a 20percent tax cut would increase the U.S. budget deficit. Pressedto explain where the money for his tax cut would come from,Romney spoke of eliminating "deductions and exemptions wekeep taking in the same money when you also account for growth."
But in interviews since the debate, Romney has promised notto touch any of the loopholes big enough to compensate for a 20percent reduction in tax rates - mortgage interest, charitablecontributions and healthcare. That has led most analysts toconclude either that Romney is not serious about cutting taxesor (more probably) that he is not serious about fiscalarithmetic and will allow deficits to explode.
There is, however, a third possibility. Perhaps large taxcuts would boost the U.S. economy so strongly that the lostrevenues would quickly be restored through rapid income growth?In the Denver debate, Romney focused on this growth theme: "Therevenue I get is by more people working, getting higher pay,paying more taxes. That's how we get growth and how we balancethe budget."
Many Democrats instinctively reject the possibility ofself-financing tax cuts, accusing Romney of "magical thinking"and likening his approach to Reagan's trickle-down economics.But let us not forget that Reaganomics proved remarkablysuccessful, generating average growth of 4.7 percent annuallyfor six years. And neither should Democrats forget thatself-financing fiscal stimulus, whether through tax cuts orpublic spending, is the essence of Keynesian economics.
Was Reaganomics successful because of Keynesian demandstimulus or conservative supply-side economics? Nobody can sayfor certain, and most likely there were benefits from bothincentive and demand effects. But either way, Reagan was hailedas a national savior. Romney would be equally lauded if his taxcuts delivered strong economic growth, regardless of whetherbudget deficits initially expand, as they certainly did underReagan.
This statement may sound like "deficit denial" - and in asense it is - but the IMF has now produced persuasive evidenceto back it up. This week's WEO reports a new study of fiscalchanges in 28 countries since the Lehman crisis, which showsfiscal policy working in much the way that Keynes predicted, butwith two to three times more impact on GDP than previouslysupposed. The very high fiscal multipliers identified by the IMFsuggest that big tax cuts could indeed be largelyself-financing, as Romney hopes.
That fiscal policy is now much more powerful than in thepast is hardly surprising. The world is again stuck in aliquidity trap, in which monetary policy is ineffective, much asit was in the 1930s, when Keynes developed his ideas on fiscalstimulus. How ironic that it now takes a conservative such asRomney to stop panicking about deficits and propose a full-scaleKeynesian policy for growth.
(Anatole Kaletsky is an award-winning journalist andfinancial economist who has written since 1976 for TheEconomist, the Financial Times and The Times of London beforejoining Reuters. His recent book, "Capitalism 4.0," about thereinvention of global capitalism after the 2008 crisis, wasnominated for the BBC's Samuel Johnson Prize, and has beentranslated into Chinese, Korean, German and Portuguese. Anatoleis also chief economist of GaveKal Dragonomics, a HongKong-based group that provides investment analysis to 800investment institutions around the world.)
Keywords: KALETSKY ROMNEY/