What Would Keynes Say About the Coronavirus Crisis?

This article was firstly posted at PanAm Post: panampost.com/editor/2020/09/01/what-would-keynes-say-about-the-coronavirus-crisis/

“We are all Keynesians now.” This phrase is commonly attributed erroneously to Milton Friedman in relation to a supposedly-accepted preponderance of Keynesian economics over the Chicago school’s free-market doctrines. Friedman himself denied having uttered this maxim. In reality, it was Richard Nixon, who later coined this phrase. But what does it mean? Could we relate it to the actual environment of economic thought amid the greatest recession since the end of the Second World War?

The coronavirus crisis spread across the West and Latin America as a completely unexpected exogenous phenomenon, breaking down our system and destabilizing our social order. Consequently, people started to ask themselves if the state could or should do more in this situation. When the real magnitudes of the economic catastrophe were presented, the central debate was no longer focused on inequities and income redistribution but on fighting poverty, saving jobs, and preserving as much productive potential as possible. Governments had to prepare a macroeconomic policy response quickly and efficiently, and it had to be effective enough to soften at least some of the inevitable effects on the mentioned areas.

More than ever, governments had to be the insurer of last resort. Keynes’ General Theory was reread by many who were trying to find a quick and efficient response, but mainstream and traditional macroeconomic policy were of no use anymore, at least in this situation. Governments couldn’t rely completely on each other anymore, and supranational institutions had very limited firepower due to excessively expansionary policies during high growth times. Fiscal capacity became one of the most repeated terms in seminars and academic discussions about economic policy to confront the pandemic. A common conclusion that was almost always reached was that this time fiscal capacity was crucial but more constrained than ever.

A crucial point to understand, and one that explains the difficulty of developing an efficient and effective fiscal policy at the time is the difference between idiosyncratic and aggregate shocks. Idiosyncratic crises are those that affect some countries, or some people some time, while aggregate macroeconomic shocks are those that affect every country, or everybody, at the same time. This crisis is a perfect example of the latter. It means that macroeconomic policy becomes much more complicated as fiscal and monetary gunpowder is not exactly laying idle. When a recession affects just a determined nation or a group of countries, allocating emergency resources and enacting countercyclical policy is much easier and more effective than when all countries are affected, and those limited resources have to be mutualized to prevent a crisis from developing into a hysteresis process. 

Often, idiosyncratic shocks tend to be no more than a process of aggressive, creative destruction – in Schumpeterian terms. So outdated companies or those operating inefficiently are displaced from the market. Further, their employed resources are reallocated to other areas of the economy through a process that can take some time, usually many years. It also includes a full downturn and recovery in terms of economic activity and growth. That is not a problem in the long term since the productive potential is constrained in the short term but tends to go back to normal after all those resources have been reallocated. Idiosyncratic shocks are economic purges, and they often tend to work in favor of the system’s own future efficiency. 

This is not the case with aggregate shocks, which are similar to a giant tsunami razing every house, every field, and every building in a country. Aggregate shocks destroy productive potential. The effects are perdurable. Therefore, the countercyclical emergency macroeconomic policy was crucial this time. The goal of the different kinds of policies developed by almost every country in the world had one single immense purpose: constrain, as best as possible, the destruction of productive potential so that the economy could recover moderately fast after the storm. Freezing the economy. Something that had never been done on a global scale. It was the moment for effective innovation in areas such as macroeconomics and public policy. Some policies, such as temporary layoff schemes, partly financed through mechanisms as the European Sure, have saved millions of jobs all around the world. Direct liquidity injections to firms that were financially sound before the COVID-19 crisis has prevented a possible liquidity crisis from turning into a solvency drama. In nominal terms, the International Monetary Fund recently released a statement declaring that countries have spent $11trn additional to their previously agreed budgets, just in response to the coronavirus crisis, which for many developed countries means spending an additional 10% of GDP. 

This will obviously have enormous repercussions on the deficit and debt levels, rising both to a scale never previously seen in peacetime. But Keynes is not to blame for this. We need to be honest, and I am not exactly Keynesian. Anyone who has studied or read Keynes will know that he was the first one to support deficit spending during economic downturns, but he also insisted -something he makes pretty clear in his General Theory– that in periods of persistent economic growth, fiscal policy should be strictly tightened to generate the necessary fiscal space to develop countercyclical macroeconomic policy during crisis periods. We need to keep this in mind. When growth recovers, we will need to confront severe public spending slashes. We will also have to reallocate the remaining government expenditure to promote efficiency as well as with austerity. Recently, Olivier Blanchard, expressing his opinion as a former member of the IMF, insisted on this. The public deficit will need to be brought down to acceptable levels under a prudent and responsible fiscal policy framework. Future generations shouldn’t have to pay for our current expenditures. The macroeconomic policy requires very high responsibility and compromise. Compromise with stability. 

We are not all Keynesians. We are not all Chicagoans. We are not all Austrians. But we should all be responsible.