Appropos the debate about Keynes below Graham Turner of GFC Economics and author of The Credit Crunch, submitted a fascinating article to the FT on this subject. In it he cites the experience of Japan’s failed attempt to kick-start the economy with public works expenditure in the 1990s.

” Between 1992 and 2002, eleven supplementary budgets were unveiled in a desperate bid to stimulate economic growth. These fiscal initiatives alone cost the taxpayer Y132.6tr. The budget deficit, using the OECD general government measure, soared to a peak of 8.0% of GDP by 2002. Between 1990 and 2005, the debt to GDP ratio climbed from 64.7% to an unthinkable 175.3%.

“And yet the policy failed, because it did not adhere to the prescription set out by Keynes. He was quite clear that the priority of any government or central bank should be to lower interest rates. Monetary policy should be the first line of attack during the onset of a depression.

” Furthermore, it might not be enough to get short term interest rates down. By 1933, short term interest rates had fallen sharply, but long term borrowing costs remained elevated. This was a major concern and strong area of disagreement at the time with classical economists. There was a problem with bond markets, Keynes argued. Investors might find it difficult to accept lower yields even as short term interest rates fell. This liquidity preference lies at the heart of Keynes’s most important and relevant lesson for today. But it is being ignored.

“Keynes succeeded in shifting the debate, and a deliberate policy to drive long term interest rates was
embraced in both the US and UK. The tide began to turn. The recovery was at times patchy. But there can be
no disputing the impact of this more radical monetary policy in providing some relief for economies scarred
by the stock market crash of 1929,and an intensifying depression. Furthermore, one can safely assume that
the policy would have been a good deal more beneficial if it had been implemented sooner. This policy of
quantitative easing can be a powerful antidote, but it has a limited shelf life. Leave it too late, and the impact
will inevitably be diluted, as deflation intensifies.

“Japan’s troubled experience highlights the perils of ramping up government borrowing before the full
range of monetary options has been exhausted.

“Every time the government announced more fiscal spending, the bond market would tumble and yields
would rise. That would drive up private sector borrowing costs, because lending rates were indirectly priced
off government bond yields. Within six to twelve months, corporate bankruptcies would start to rise again.

“This was a classic case of ‘crowding out’. The looser fiscal policy was accelerating the slide into deflation, as more and more companies defaulted. “