The Brief – The Keynesian times are over

5 months ago 27

Faced with the far-reaching implications of the COVID-19 pandemic in 2020 and a mounting global energy crisis from 2021 onwards, European governments have embraced a Keynesian approach, spending billions to keep companies afloat and help consumers. But those times are over.

As many economics students have long learnt through a widely popular 1994 rap video, macroeconomic policy can be described as a back-and-forth between two competing schools of thought.

One is the classical liberal theory, which bets on markets to restore equilibrium naturally and argues for minimal state intervention.

The other is Keynesianism, which assigns a much bigger role to governments, particularly in fighting off economic crises, and builds on the premise that even in tight economic conditions, spending is needed to spur spending.

Contrary to the 2012 European sovereign debt crisis, which was accompanied by a sweeping rise of austerity policies—hinging on the opposite theory that during economic crises, governments need to turn off the tap of public spending—the COVID pandemic saw the Keynesian approach dominate across the bloc, preventing what was threatening to turn into the biggest shock to European economies since the Second World War.

European governments spent billions to keep people in jobs via furlough or short-work-schemes, supported by the EU’s SURE program, which enabled more favourable lending conditions for an additional spending of €98 billion.

The crisis also led the EU to overstep a previously critical red line for many countries, taking on joint debt and dispersing the money to member states through the “Next Generation EU” recovery programme, initially worth €723 billion.

Many, including Germany’s finance minister at the time, Olaf Scholz, called for a “Hamiltonian moment” for Europe. They referred to the first US Secretary of the Treasury, Alexander Hamilton, who initiated America’s first government borrowing, which has not vanished since.

The Keynesian momentum was rounded off by a European Central Bank (ECB) that not only kept interest rates low but also actively called for fiscal and monetary policy to work together to regain economic growth – something that was long unthinkable given the ECB’s strong focus on independence and its primary mandate to only focus on price stability.

While it seemed for a while that the mounting energy crisis and the need for higher military spending that followed Russia’s invasion of Ukraine in early 2022 would force governments to keep pouring money into the economy, four years later, that momentum seems to have run its course.

Or at least that’s what popular British economist Adam Tooze, a convinced Keynesian, ascertained at a German event on ‘fiscal futures’ on Saturday (23 March).

The ECB has set interest rates so high that many have started moaning about their impact on economic growth, and the possibility of a permanent joint EU fiscal policy now looks rather unlikely.

The hoped-for “Hamiltonian moment”, which implies that the joint European borrowing of the Recovery and Resilience facility would continue after the end of the current programme in 2026, is nowhere to be seen. Such a continuation is strongly opposed by the increasingly dominant austerity-prone political forces of the centre-right.

The Social Democratic leader Olaf Scholz, now German chancellor, has stopped mentioning it too and instead opted to visit an event in Berlin last week that honoured liberal economist Friedrich August von Hayek – the most eminent proponent of the Austrian School of Economics and of of free-markets capitalism.

Scholz told the event that a soft landing would be needed to phase out government spending and state subsidies and revert sustainably the “incredible fiscal expansion” that has taken place over the last few years.

With the adoption of the EU’s new fiscal rules, which will force governments to slash spending as of next year, this shift is also written into law.

Political forces promoting fiscal restraint—such as Estonia’s Prime Minister Kaja Kallas or German Finance Minister Christian Lindner—are brimming with energy. They argue that private capital, not state support, is needed to solve the problems of our time, such as the need to produce more weapons and ammunition and shift towards a greener economy.

Thus, on the legislators’ side, the shift from a prevailing narrative for post-pandemic EU-level funding resources to a new-found enthusiasm for the potential of private markets and private capital to shore up the bloc’s economy is clear—compounded by a revival of the EU Capital Markets Union rhetoric.

Proponents of Keynesianism haven’t given up, though.

Talking to Euractiv, analysts from the leading UK New Economics Foundation, Brussel think tank Bruegel and global union IndustrALL warned against this policy shift as misguided and argued that public money, which functions differently from private capital, will be vital in guaranteeing the bloc’s economic transition towards green energy systems.

Tooze agreed that “there is no alternative to public investment when it comes to the historical challenges of the present – whether we are talking about climate, migration, technological change or even geopolitics”.

But as the pandemic crisis fades into oblivion, it seems that their message is increasingly falling on deaf ears.

*Additional reporting by Anna Brunetti

** Dear readers,

The Brief will take a short break and be back with you on 8 April.

The Roundup

The EU and US are in close contact over artificial intelligence (AI) risks and mitigation, including a possible partnership for a framework on generative AI, according to an unreleased draft statement, seen by Euractiv, for a joint meeting to be held on 4-5 April.

A debate over children’s addiction to digital technology, and what can be done about it, is gaining support in France, while at an EU level, there are rumblings for regulation on addictive design.

During a three-day official visit to Brazil, French President Emmanuel Macron floated the idea of a new EU-Mercosur deal which could go beyond just trade while critics and supporters await the finer details.

A new compromise text of the draft legislation to detect and remove online child sexual abuse material (CSAM) by the Belgian Presidency of the European Council, seen by Euractiv, focuses on risk assessment, detection orders, and reporting.

French MPs have backed a bill to expand intelligence services competencies to monitor networks, re-opening a debate on democratic control of these agencies.

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