Deficit spending didn’t end the Great Depression and it won’t save us now

Paul Ormerod
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JOHN Maynard Keynes is on many minds at the moment. Lots of talking heads are prescribing a dose of Keynesian medicine: more spending and borrowing. However, Keynes didn’t get us out of the Great Depression and he should be ignored today.

The 1930s and the Great Depression are often cited as an exemplar. Some assert that deficit spending saved us then, so let’s do the same now. This is an urban myth.

In May 1933, at roughly the same stage in the cycle as we are now, Keynes made the case for tax cuts and infrastructure spending to boost growth and reduce unemployment. He had little time for fiscal masochism, noting: “The more pessimistic the chancellor’s policy, the more likely it is that pessimistic anticipations will be realised and vice versa. Whatever the chancellor dreams will come true”.

Despite his eloquence, Keynes did not then influence policy either here or in the US. Fiscal masochism continued to be dominant.

When Keynes urged more spending and more borrowing in 1933, the economic situation looked dire. In 1932, real GDP only grew by 0.8 per cent. Unemployment was at a record high of 14 per cent. The table shows what happened next (while spending as percentage of GDP fell).

No sooner had Keynes made his intervention than optimism broke out. The economy boomed and unemployment nearly halved. The same happened in the US. Its economy grew even faster than the UK’s, by 7.7 per cent in 1934, 7.6 per cent in 1935 and an astonishing 14.2 per cent in 1936.

The key to a sustainable recovery is the private sector. Companies innovate, invest and create jobs. Today, many of Europe’s large companies are sitting on massive piles of cash. If confidence is restored, this cash will be spent and we will see growth rates similar to those of the mid-1930s.

The fact that corporate sentiment recovered in the 1930s is no guarantee the same will happen today. But a stable framework is needed, with no surprises.

Countries like France, Spain and Italy must come clean about the position of their banks. The leaking of bad news in dribs and drabs has a wholly negative effect on confidence. We must know the true position now. Of course, people only want to be told the truth by their doctors if they’re well. But getting everything out into the open is a much better way to improve business confidence than the current veil of secrecy.

Paul Ormerod is an economist and his book Positive Linking is published by Faber on 4 July.