Keynes and financial blood transfusion: understanding the doctor’s prescription

by Marc Morgan

A complement to From Dr Keynes to Financial Bloodletting

“I work for a Government I despise for ends I think criminal” (John Maynard Keynes, 1917).

This would certainly be Keynes’ position today if he were unfortunate enough to work under the current British Government, or any EU government for that matter. The criminal ends can be attributed to contemporary ‘financial bloodletting’, whose practice can indeed be heralded as criminal. The earlier piece which Antoine Cerisier and I wrote deals broadly with the ideological change from Keynesianism to neo-liberal ‘austerianism’ that occurred in the latter half of the 20th century. But what was Dr Keynes’ idea, which gave rise to ‘Keynesianism’ and which has now been replaced by financial bloodletting?

Keynes’ idea, as portrayed in Dan Cryan, Sharron Shatil and Piero’s brilliant graphic introduction to Capitalism, is that money’s role in the economy closely resembles that of the bloodstream in the human body, with individual demand units resembling blood “cells”. As long as money continues to ‘circulate’ in a market economy, balance can be maintained and growth achieved. Each demand unit in the body of an economy represents “an individual, a family or a business”. The money spent by one unit fuels the income, and thus the consumption, of another. It is here where we begin to see the economy-household analogy breaking down. Reducing the earning/spending power of individual demand units will do damage to the entire body.

From this logic Keynes believed that recessions occur when, put simply, money is prevented from circulating in the economy. This happens when the demand units either accumulate money, in the case of banks not lending or investors being wary of the future and saving, or when the demand units are, by design through austerity or by circumstance through excessive debt obligations, made to reduce their demand. In response to recessionary pressures Keynes advocated that the state, i.e. government, should provide more money through a ‘financial transfusion’, as sane medical doctors would if their patients suffered blood loss. In the economy this can be achieved by lowering interest rates, to encourage borrowing or by simply printing more money and directly spending it in the economy to regenerate a healthy circulation within the system. This public expenditure, in the form infrastructural projects and public services, could also have an eye on improving living conditions for ordinary people and reduce inequalities, something Keynes was a strong supporter of. What this rationale shows is that ‘Keynesianism’ identifies the correct symptoms of the disease, unlike traditional and financial bloodletting which concentrate respectively on human deficiency and irresponsibility rather than on the more significant respective symptoms of living conditions and conventional work practices. Keynes sought, through the policy he advocated, an improvement in both of these conditions. For example, in relation to work practices Keynes was an ardent critic of financial speculation, to the point where he preceded James Tobin in proposing a financial transactions tax in Book IV of his General Theory of Employment, Interest and Money (1935). 

As noted in the preceding article on the subject, Keynesian policies of alleviation have given way to financial bloodletting, embodied in the present wave of austerity in Europe. This is not to say that Keynesian inspired thought is completely off the radar. In the immediate aftermath of the financial crisis in the autumn of 2008, governments around the world, led by the US, engaged in stimulus injections termed “quantitative easing”, which characterised the following 12 months. However this policy was short lived, especially in Europe, as (unproductive) bank bailouts by sovereigns began to take their toll on state budgets and on national debt. Yet in 2012 Keynesian inspired policies have found renewed voice, for example within the ‘Roosevelt 2012’ collective. But still, the most radical extension of Keynes’ financial ‘transfusion’ has not been given any light and under the current political regime it is not due to. The idea is, however, as natural as the working of the human bloodstream.

Douthwaite (1942-2011)

The idea has been given the name “deficit easing” by its proponents. It was conceived by the late Irish economist Richard Douthwaite, as an alternative to the severe austerity programmes enacted throughout Europe since 2010 and also, it may be said, to “quantitative easing”, which has had no effect on the US money supply. With “quantitative easing” the central bank creates new money and buys bonds from private banks so as to provide them with more liquidity. However, as Douthwaite correctly identifies, this is where problems have arisen because in the present climate “the public has been unwilling to borrow, or the banks have been unwilling to lend”. The idea of “deficit easing” is that “carefully-controlled amounts of non-debt money” created by the central bank, namely the ECB in Europe, would be handed directly to national governments, as a form of grant, so that they can effectively reduce their public debt immediately. The money, which would be assigned to different countries in proportion to the size of their debts and populations, would also be given to individuals so as to reduce the burden of private debt. Any money left over could then be spent in the real economy, or as Douthwaite argues, spent on financing the transition to renewable energy in the E.U. In Keynesian medical terminology, blood clots (the overhang of debt) could be immediately removed and demand units (blood cells) reinforced.

The advantages of this proposal would be that it would prevent the need for continued reductions in budget deficits which contribute to weaken aggregate demand and the economy, and that the money created would be interest free and hence debt free, alleviating a country’s total debt burden. Therefore there is no issue with combating debt by ‘borrowing and getting more into debt’. This idea may seem too simple and possibly ‘too good to be true’. However, there is no economic theory which states that it cannot be done. In fact a debt-free national currency has been a feature of the past, from the American colonies prior to the Revolution, to early 20th century industrial policy, as advocated by Henry Ford and Thomas Edison, and to the small economy of Guernsey in the Channel Islands.

This form of money creation would naturally confront two objections, apart from the fact that it is not within the ECB’s mandate; a mandate which in the end only reflects the will of political representatives. The first is that “deficit easing” would be highly inflationary, the second that it does not punish countries enough or correct budgetary mismanagements. In relation to the first of these, the argument of ‘too much money chasing too few goods’ would not apply in this case since there are a lot of goods, namely debts in need of repayment, which require money not currently available. Also there is a considerable “surplus capacity” in most Eurozone economies. At the point where prices do begin to rise at a fast rate the ECB could halt any further money creation, national governments could ‘withdraw’ money through taxation so it does not accumulate, or they could raise banks’ capital-requirement ratios if private sector borrowing begins to take off too rapidly. The second argument is all too familiar with financial bloodletters. The result of “deficit easing” is exactly what the bloodletters seek – a reduction in debt, but unlike the bloodletters it does not achieve this by sucking the blood out of the body that it is meant to heal. Rather, once deficits and debts are sufficiently reduced by a (debt free) financial transfusion, and countries return to being in a healthy state, only then should rules and regulations be imposed, if necessary, to ensure ‘responsible’ budgetary management for the future. But punishing the patient with more pain while it is still suffering from chronic illness is criminal practice.

The radical Keynesian policy of “deficit easing” only reflects the sense Keynes made of the economy, much like the bloodstream in the human body – systems where a healthy circulation of demand and blood is necessary for the welfare of the whole. In medical practice as with economic practice, therefore, bloodletting should give way to blood transfusion.

  1. Thanks for the article. I have not studied economics with huge depth but I would be interested to know your thoughts. I have no real issue with Keynes’ economic principles. They are a good financial model that if deployed properly, work.

    However we may currently have a Government in the UK who do not sign up to these principles, but surly the Brown Govt were far worse. They told the world they were true Keynes economists, yet did anything but stick to Keynes’ rules – namely “Austerity in the good years so that you can spend in the bad”.

    I can fully appreciate the ability that Keynesian spending could have if in the good years we had saved, but as we ran massive budget deficits this just was not a position that either our Government of the EU were able to deploy.

    If in the good years we were out spending and out growing the true growth there needs to be an element of contraction in our economy as what we were seeing was a mirage of prosperity rather than an actual representation of growth in our nation.

  2. Thank you Joseph for your comments. Apologies for the delay in my reply.

    I think within the nature and structure of a capitalist economy, Keynesian policies are very rational – they serve the capitalist system well, whose ultimate goal is capital accumulation and output growth. In isolation the policies are humanly shallow, being completely at the mercy of consumption demand. This is not to say that Keynes himself was a humanly or morally shallow individual. Keynes was a very influential figure in design of the American ‘New Deal’ and the development of the welfare state in Europe in the post war period, which sought to place an equally distributed human welfare at the centre of public policy. What has since come to be known as ‘Keynesian policy’ focuses exclusively on state-led expansionary measures. Within the capitalist paradigm they ‘work’ – they do what the economic system requires them to do: they decrease unemployment, put idle capital into use and usually increase national output. However centring our society around maximising consumption, in whatever way, is not, for me at least, a desirable society. Yet taking this maxim for granted as central to the health of the economic system, ‘Keynesian’ policies are the most effective at realising it.

    As far as the previous Labour government was concerned I was never aware that they described themselves as ‘true Keynesians’. In the article which Antoine Cerisier and I wrote on the issue of financial bloodletting we highlighted how one of new Labour’s key figures, Peter Mandelson, admitted in 2002 that his party and other major parties were “all Thatcherites now” following two decades of an increasingly accepted neo-liberal consensus (made partly in Washington and partly in London). The thinking that embodied ‘Thatcherism’ was radically anti-Keynesian, and it lasted through the Labour years. By the time the ‘Brown government’ was conceived in 2007 there were no ‘good years’ left to do any manoeuvring, so I do not agree with your point on that. But I agree that it is rational to save small, consistent amounts when times are good, as a precaution to a worsening state of affairs.

    Keynesian stimulus-spending does not necessarily have to come from saved money however. The money can be borrowed for productive spending, or printed for ‘deficit easing’ purposes if the circumstances are severe enough, as they are at present in Europe.

    The ‘mirage of prosperity’ you mention, which I do not dispute, was the result of successive neo-liberal policies which positively influenced the consumption demand of the very fortunate and little else, while ‘growth’ spending was channelled to largely unproductive ends, like fighting illegitimate wars. ‘Contracting’ will only exacerbate the distributional issue, and weaken the economy, if carried out symmetrically to an expansion. ‘Reforming’ (the tax system, public services etc), to increase public spending power and spur a shared growth in a way the is cost-effective over the long run and morally feasible, rather than simply ‘contracting’, would be akin to a healthy prescription for a capitalist economy.

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