One of the most well-known lines in John Maynard Keynes’ General Theory notes how politicians think of themselves as reacting to “events” when they are in fact “usually the slaves of some defunct economist.” The latest G-20 meeting, held last month in Toronto, proves Keynes’ wisdom once again -- with a twist. The G-20 meeting ended with a collective endorsement of “growth-friendly fiscal consolidation,” which assumes that if G-20 member states tighten their fiscal belts, states will have to borrow less, pay less interest, and, therefore, will not “crowd-out” private-sector growth. Such a strategy may sound sensible, but it relies on the same fallacy of composition that brought on the banking crisis -- that by making individual banks safe, you make the system as a whole safe -- only in reverse. That is, although it may make sense for any single state (or firm or household) to clean its balance sheet, if all the G-20 states embark on such a course at once, the results could be disastrous. The whole -- Keynes’ critical insight -- is not equivalent to the sum of its parts. The finance ministers of the G-20 states seem to believe that by retrenching in the middle of a recession, they will somehow improve their states’ balance sheets and thus return to a period of economic growth. Deflation, in other words, is now good for growth. How did we get here?
Less than two years ago, the world’s financial institutions pleaded for a taxpayer-funded bailout of
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