Australian Journal of Political Science,
Vol. 45, No. 3, September 2010, pp. 353–369
The Return of Keynesianism in Australia:
The Rudd Government and the Lessons of
Recessions Past
ALAN FENNA
Curtin University
The global recession of 2008–09 brought Keynesian countercyclical
budgeting back into vogue – conveniently for governments of the Left such
as the incoming Rudd Labor government in Australia. This paper reviews
some of the key moments of 20th century macroeconomic policy to assess
the reasons and rationale for this revival and concludes that the lessons of
those experiences are not always what they seem to be. The paper argues
that: (1) Keynesianism is often confused with a narrow focus on fiscal,
rather than monetary, policy and an emphasis on full employment at any
cost; (2) the return of Keynesianism in Australia has only been made
possible by an unusual, if not unprecedented, convergence of conducive
conditions; (3) the ‘automatic stabilisers’ significantly reduce the necessity
for discretionary fiscal policy; and (4) policy achievements must be seen in
the light of Australia’s external economy.
Background
Elected to office in November 2007 as the economy continued its 16-year
growth run, the main economic challenge faced by the incoming Labor
government in Australia was how to deliver on its spending and tax cut
promises without stoking inflation. Within only a matter of months, the
situation had reversed and Labor was confronted with the global financial crisis
and ensuing global recession. The government responded unhesitatingly to the
new threat with a succession of financial support and economic stimulus
packages. Embracing the policy of countercyclical deficit spending with
enthusiasm, Prime Minister Rudd made clear his government’s willingness to
see Australia spend its way out of the recession. After a long period in the
wilderness, Keynesianism was back. And, moreover, it seemed to be back with a
flourish. While according to the IMF (2009), 2008–09 was ‘by far the deepest
global recession since the Great Depression’, Australia sailed through almost
Alan Fenna is Professor of Politics at the John Curtin Institute of Public Policy. He thanks John
Phillimore and the Journal’s reviewers for questioning his interpretations.
ISSN 1036-1146 print; ISSN 1363-030X online/10/030353-17 Ó 2010 Australian Political Studies Association
DOI: 10.1080/10361146.2010.499863
354
A. FENNA
unscathed — being one of only three OECD countries not to record negative
growth over the year.
‘In its response to the global recession’, Prime Minister Rudd (2009) declared,
‘Australia has sought to learn some lessons of recessions past’. The lesson that
the Prime Minister drew from that past experience was the importance of
‘strong, early and decisive action’ along Keynesian lines. The value of learning
from the past in economic policy making is indisputable – after all, that, along
with comparative experience, represents the bulk of what we have to go on
empirically. Rather more disputable, though, is exactly what lessons we should
learn from those previous experiences. This paper argues that the lessons of this
recession, and of recessions past, are rather different from what the Prime
Minister suggested and, indeed, from what is often assumed.
The return of Keynesianism re-opens long-running questions about the
scope and means for political control of the economy and the capacity
for achieving ‘full employment’ in a capitalist society. Keynesianism is a
touchstone of the left and critics argue that since the mid-1970s the full
employment objective has been sacrificed on the altar of ‘neoliberalism’:
governments choosing to tolerate persistent and sometimes high unemployment when more humane approaches were available. This paper takes issue
with that view, arguing: (1) that, too often, Keynesianism is confused with
‘fiscalism’, or the view that economic management should be done
predominantly through taxing and spending, and ‘functional finance’, or the
view that short-term macroeconomic considerations should always take
precedence in fiscal policy; (2) that the current burst of Keynesianism has
been made possible only by a highly unusual convergence of a number of
necessary conditions; (3) that the ‘automatic stabilisers’ of today’s welfare
state make discretionary fiscal policy much less necessary than in the time
that Keynes was writing; and (4) that Australia’s performance is heavily
influenced by external factors beyond its short-term control. Keynesianism
must be seen as largely a creature of time and place, with timeless lessons but
limited direct applicability to any of the circumstances that have prevailed
since the 1930s.
Keynesianism and the ‘Full Employment’ Objective
The formative event behind the revolution in economic policy represented by
Keynesianism was the Great Depression of the 1930s, a downturn
distinguished from anything that has occurred since by its depth, its duration
and its deflationary character, as well as by the very limited degree of social
services governments then provided. What created the conditions for a
‘revolution’ in economic policy was the degree to which the Great Depression
was so evidently a ‘disaster of perverse economic policies’. These were policies
that reinforced the downward spiral in a ‘procyclical’ way rather than
attempting to arrest it ‘countercyclically’ – most notably, disastrously tight
monetary policy (Ahamad 2009; Bernanke 1995; Eichengreen 1992; Eichengreen and Temin 2003; Hall and Ferguson 1998; Kindleberger 1986; Romer
1992). The Great Depression was not Australia’s worst downturn – that
honour is claimed by the Depression of the 1890s (Fisher and Kent 1999),
which paved the way for Federation – but it has been described as ‘an
THE RETURN OF KEYNESIANISM
355
economic catastrophe of the first order’ and ‘the dominating economic event
in Australia’ of the 20th century (Valentine 1987, 61).
Put most simply, Keynesianism is the predisposition toward countercyclical
rather than procyclical economic policy. It proposes that: (1) markets are not
self-equilibrating and, in particular, are inherently prone to periods of
involuntary unemployment typically caused by insufficient effective demand
to stimulate adequate levels of investment and employment; (2) through their
influence on effective demand, governments have both the capacity and the
responsibility to moderate the extremes of the business cycle so as to reduce
unemployment; (3) thanks in part to the ‘multiplier’ and ‘pump priming’ effects,
budget deficits generated by stimulatory fiscal policy are legitimate and
correctable; and (4) there is a psychological component to economic behaviour
that increases the returns to policies of economic stimulus. Keynes focused on
the need for appropriate monetary and fiscal settings, with the emphasis
dependent on circumstances, but he was particularly outspoken about the
contribution that a fiscal stimulus could make through large programs of public
capital investment since they would yield what we could call a ‘triple divided’ of
direct job creation, indirect job stimulation and long-term structural benefit. It
is the proposition that countercyclical demand management will pay for itself
that led Krugman (2008, 191) to extol Keynesianism as the economics of the
‘free lunch’. That said, there is no shortage of variants, from the ‘neoclassical
synthesis’ and the mechanical textbook version that Coddington (1976, 1264)
labelled ‘hydraulic Keynesianism’, to the more radical ‘Post-Keynesian’
perspectives.
The victory of Keynesianism was, if not total, certainly rapid and extensive.
What had been a number of provocative proposals in the 1920s and early 1930s,
and became a manifesto with the publication of Keynes’s (1936) General
Theory, ‘had more or less established itself as the new orthodoxy’ by 1945
(Bleaney 1985, 83). It represented a major watershed in Australian public policy
as it did elsewhere. It was officially signalled by the release of the Labor
government’s 1945 White Paper Full Employment in Australia, a policy
statement that followed the British lead and had Canadian and American
equivalents.1 The White Paper declared that ‘Full employment is a fundamental
aim of the Commonwealth Government’ and that ‘governments should accept
the responsibility for stimulating spending on goods and services to the extent
necessary to sustain full employment’. Following Keynes, it singled out
infrastructure spending as the most expedient way to boost effective demand. It
also acknowledged, though, that none of this is without risk. ‘Careful and
detailed advance preparation will be required if public capital expenditure is to
play a significant part in our development’. In addition, a spending-based
approach creates the danger of ‘unstable public finances’, and full employment
means government will need to ‘ensure . . . that undue sectional pressure for
wage increases does not lead merely to a rising spiral of wages and prices
1
The British White Paper, Employment Policy, of 1944; the Canadian White Paper, Employment
and Income, of 1945; and the US Full Employment Act of 1946. The American statement was the
only one to assume any formal or legal standing; the others remained merely White Papers. That
said, the American commitment to Keynesianism in the Full Employment Act was considerably
watered down at the insistence of business.
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A. FENNA
without any real benefit – and perhaps with disadvantage – to the workers
themselves’. Governments would have to keep public spending within bounds
and build in mechanisms for controlling inflation.
Keynesianism and Social Democracy
Notwithstanding the fact that Keynes’s ‘patrician liberalism’ (Pierson 2001,
40) was quite at odds with the core elements of social democracy –
particularly unions, which Keynes (e.g. [1926] 1972, 309) greatly deplored –
there has always been a powerful affinity between Keynesianism and social
democratic politics and policy. And although some prominent exercises in
Left Keynesianism have been anything but successful – the Blum government in 1930s France and the Mitterrand government in 1980s France most
notably – the affinity is strong. Arguably, it was Keynesianism that made
social democracy viable: providing a way to square the circle of social reform
in a capitalist economy by giving government responsibility for macroeconomic management and justifying progressive taxation and redistributive
public spending.
Although Hibbs’ (1977) original proposition that left-wing parties are
naturally more Keynesian has been supported by others (see, for example,
Cusack 2001; Hall 1989, 376), more recent research suggests that it was
much truer of Hibbs’ period – the 1960s and 1970s – than it was of the
1980s and 1990s. After the failings of loose fiscal and monetary policy in the
1970s, argues Sakamoto (2008), parties of the left came under pressure to
reform their ways and became as – or, indeed, more – fiscally responsible
than parties of the right, and delivered improved economic outcomes as a
result.
One of the touchstones of the economic policy consensus that has emerged
out of this convergence is the commitment to ‘balancing the budget over the
economic cycle’. This was adopted in Australia by the incoming Coalition
government in 1996 and endorsed by the Labor government following their
return to office in 2007. Britain’s incoming Labour government had adopted the
same stance a decade earlier. Critics of Britain’s ‘New Labour’ have argued that
this ‘fiscal conservatism’, as Prime Minister Rudd called it approvingly, means
that parties of the left have forsaken their Keynesianism and their commitment
to full employment (see, for example, Arestis and Sawyer 2001, 2003, 2004; Hay
2004, 2007; Whyman 2006). They accuse Labour of having abandoned the
Keynesian emphasis on countercyclical fiscal policy by transferring primary
responsibility to monetary policy and committing to balanced budgets over the
cycle. In Whyman’s (2006, 220) view, this must be reversed. ‘The revitalisation
and evolution of Keynesian macroeconomic strategy is quite simply a
prerequisite for a successful progressive–social democratic approach to
economics.’
These critics overlook, though, both the extent to which economic policies
must be fit for circumstances and the nuances of Keynesianism itself (see,
for example, Clift and Tomlinson 2007). Keynesianism operates, like most
other things, in a constrained world in which fiscalism may not always be the
answer and social democracy does not have a fixed identify (Hindmoor 2005;
Moschonas 2002).
THE RETURN OF KEYNESIANISM
357
Constraint Factors
In practice, Keynesianism has always faced a number of challenges, including
inflationary pressures; the challenge of timeliness; fiscal imbalance; and the
external economy. Prominent among these is the ‘inflation bias’ – Keynesianism’s potential to generate a disabling inflation through either or both of
its support for full employment or its predisposition toward loose monetary and
fiscal policy. From a Marxist perspective, free-lunch Keynesianism represents
another instance of naı̈vité about the easy reconciliation of the conflict between
capital and labour. In his 1943 article ‘Political Aspects of Full Employment’,
Michał Kalecki argued that Keynesianism would be politically infeasible
because business would not accept a framework that diminished their influence
over public policy and their workplace authority over labour. Then, in a
following article, Kalecki ([1944] 1990) argued that over the longer run
Keynesianism would be economically infeasible: full employment is another one
of those things that is too good to be true. In the full employment economy’s
tight labour market the bargaining power of workers ‘will be very strongly
enhanced’ and wage pressures will mount. The inflationary pressure of full
employment in the absence of controls seemed to be empirically confirmed by
A.W. Phillips’ (1958) famous study of British wage rates and employment
levels. A century’s worth of data reveal, he advised, ‘a clear tendency for the
rate of change of money wages to be high when unemployment is low and to be
low or negative when unemployment is high’ (Phillips 1958, 290).
Keynes wrote in a period when inflationary risks were minimal or nonexistent – an era of chronic deflation and generally ‘morbid’ expectations about
the future (Overy 2009). By the time the Great Depression struck, the UK had
already suffered through several years of economic stagnation, policyencouraged deflation and high unemployment. Nothing like such a deflationary
stasis has occurred since. The great contrast between interwar conditions and
those prevailing ever since is partially obscured by misuse of the term ‘deflation’
or ‘deflationary’ today to describe policies directed at reducing the inflation rate
(see, for example, Bell 2004, 37–9).
Keynesian economics also took shape in a period when timing was scarcely
an issue. The tragedy of the interwar period was the sheer persistence of the
slump. In both Britain and (as a consequence) Australia, the economy had
already been in a deflationary recession before the Great Depression even
struck in late 1929. For much of the period since the end of the war, the
ambition of Keynesians has been the very different one of moderating short-run
cyclical fluctuations in growth rates – sharp rises or falls that last 18 months or
less. This was ‘fine tuning’ – rapid, relatively minor adjustments to monetary
and fiscal policy that would anticipate those annual movements. It required a
timeliness and calibration well beyond anything Keynes contemplated. The
problem is one of uncertainty and the tendency of economic policy to lag too
far behind the cycle, taking effect either when it is no longer needed or, worse
yet, when it has become damagingly procyclical. This is particularly the case
with fiscal policy, which can have pronounced ‘decision lags’ and ‘implementation lags’ (Blanchard and Perotti 2002). As John B. Taylor (2000, 27) has noted,
monetary policy enjoys a distinct ‘comparative advantage over fiscal policy’ in
these regards. ‘Experience has shown that the implementation lags are much
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A. FENNA
shorter for monetary policy’ and, in addition, monetary policy decisions are
much easier to reverse.
Keynes sought, above all, to liberate economic policy from the perversely
procyclical balanced budget orthodoxy that required governments to cut
spending and/or raise taxes to restore public finances in an economic
depression. Thus, the test of Keynesianism in the popular mind is the
government’s willingness to engage in deficit spending. However, for Keynes,
deficit spending was a ‘last resort’ and one that ‘would be a sign of failure of the
government’s overall economic stance’ (López 2003, 34). It was also very much
a temporary measure, justified on the basis that it would be self-correcting. This
is fundamentally different from the extreme ‘functional finance’ (Lerner 1943)
doctrine that sees ongoing deficits as unproblematic and the maintenance of full
employment as the only valid consideration for fiscal policy. That view is much
more closely associated with Kalecki (see Feiwel 1975, 182–8) than it is with
Keynes.
Sweden’s pioneering experiment with democratic Keynesianism in the Great
Depression illustrates the point well. Contributing to the great success of the
Swedish Social Democrats in deficit spending was the way they anticipated the
deficit concern from the outset – crafting their fiscal framework in a way
explicitly directed to returning the budget to balance. For leading Swedish
Social Democratic economist Gunnar Myrdal (1939, 107), this was a point of
great importance: ‘The chief problem of fiscal policy in the business cycle’, he
argued, is ‘to design formulas for public finance which, as part of the regular
system, make room for deficit spending during depressions by securing the
building of corresponding surpluses in good years.’ Myrdal (1939, 193) also
acknowledged that ‘making room’ for countercyclical fiscal policy is easier said
than done; balancing deficits with surpluses ‘assumes normal business cycles
with good times alternating with the bad ones’.
Finally, there is the problem of the international economy. When Keynes
([1931] 1972, 138) was first promoting the idea of spending one’s way out of the
Depression, he reminded people that not only should they be out there buying
goods, they must be buying ‘British, home-produced goods’ if the desired
impact was to be achieved. Given the propensity to import and reliance on
export income, ‘Keynesianism in one country’ is unlikely to be an option for
anything but a very large economy. It is well recognised that this is particularly
the case for Australia (see, for example, Gregory 1991, 111; Macfarlane 2005).
The Great Depression in Australia
Most important of the ‘lessons of recessions past’, according to the Prime
Minister, is the lesson of the Great Depression. ‘The alternatives’ to the
government’s stimulus packages, ‘were to do nothing or, worse, effectively
replicate the Premiers’ Plan of 1931 when governments cut expenditure, thereby
compounding the problems created by a private sector already in retreat. The
result, of course, was an economic rout, appalling unemployment and a decade
of negligible growth through the 1930s’ (Rudd 2009).
Unfortunately, the data tell a rather different story. By the time the Premiers’
Plan was inked, Australia had been in recession for over three years. Indeed,
because of its symbiotic ties to the British economy, which had been languishing
THE RETURN OF KEYNESIANISM
359
through the decade, the Australian economy struggled through the entire
period (Schedvin 1970, 49 and passim). The recession of the late 1920s
culminated in the economic collapse of 1931 when GDP contracted by a
catastrophic 9% (Valentine 1987, 65). Policy responses were tariff increases,
currency devaluation, wage reductions and the Premiers’ Plan of a reduction in
interest rates and the classic deflationary measures of orthodox public finance:
public spending cuts and tax increases. Almost immediately from that point on,
the Australian economy recovered strongly. The following year saw an 11%
turn-around in GDP performance to growth of 1.7%, and the succeeding year,
1933, saw the economy grow an extraordinary 6%.
Since ‘the Depression was almost completely imported’ (Valentine 1987, 76),
recovery was dependent on external factors, notably access to cheap capital and
demand for exports. The annus horribilis of 1931 followed directly from a
collapse in exports and a blow-out in Australia’s current account deficit to 11%
of GDP. Policies that supported export competitiveness – such as reducing
wages (Valentine 1987, 73) – contributed to recovery but, to a large extent,
Australia was at the mercy of British markets. Stimulating domestic consumption through deficit spending could not have addressed the external nature
of the problem. At the same time, Australian governments were hobbled by
massive public debt inherited from Commonwealth government expenditure in
the First World War and State government infrastructure expenditure in
the 1920s and earlier.2 Furthermore, the bulk of this debt was held overseas
in the UK. All of this helps explain why Keynes himself publicly expressed
wholehearted support for the Premiers’ Plan and associated actions (Markwell
2000). ‘I am sure the Premiers’ Plan last year saved the economic structure of
Australia’, Keynes (1932) forthrightly declared. Keynesianism was undoubtedly
the right policy for other countries, but it was not feasible in the Australian
context. If there were obvious mistakes made, they lay most obviously in the
realm of monetary policy, which was ‘tragically tight’ (Gruen and Clark 2009,
41). Australia was no different in this regard than the United States, where the
real interest rate reached a punishing 20% in the depths of the Depression
(Cecchetti 1992, 150).
Bring Back the Golden Age
For a number of commentators (Battin 1997; Bell 2000; Dow 2008; Nevile
2000), the question has been why have we waited so long to restore
Keynesianism to its rightful place in Australian economic policy making? In
their view, the Keynesian demand management techniques used so successfully
in the 1950s and 1960s have been abandoned in favour of a callous
‘neoliberalism’. The crux of this argument lies in the proposition that there
has been, in Stephen Bell’s (2000, 2–3) words, ‘a major re-orientation away
from the postwar commitment to full employment’. Either explicitly or
implicitly, this re-orientation is interpreted as representing a distinctly political
choice, not one driven by or reflecting economic imperatives. Battin (1997, 8)
2
In 1932, Commonwealth government debt reached 60% of GDP and the aggregate government
debt reached its all-time high of 205% of GDP (Barnard 1987, 256–7).
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A. FENNA
claims that ‘a reliance on economics alone to explain something like the shift
away from Keynesianism is a barren enterprise’.
Harking back to the Keynesian golden age of capitalism of the 1950s and
1960s is, as Macfarlane (1997) puts it, the ‘economics of nostalgia’. The
economic performance of the period – ‘capitalism’s great leap forward’ (Beaud
2001, 213) – was indeed extraordinary, but little of that can be attributed to
policy. Rather, the postwar boom was the result of underlying economic forces.
From a different position on the ideological spectrum, Andrew Glyn (1995)
judged similarly: ‘It is doubtful that ‘‘free lunch Keynesianism’’ . . . was ever
very important in accounting for post-war full-employment.’ The postwar
boom not only made Keynesian economic management largely redundant as
far as ensuring full employment was concerned, it also contradicted, in a deeper
way, Keynes’ own underlying pessimism about the continuing vitality of
capitalism. Presumably, Keynesianism contributed to the virtuous circle of
investment and growth – at the very least by its impact on expectations and,
hence, consumption and investment decisions (Boltho 1989; also Nevile 2000).
However, those high rates of investment and growth also eliminated many of
the profound challenges of economic management that confronted governments before the war.
The overwhelming feature of the postwar experience is the way that economic
vigour caught economists and policy makers in Australia and elsewhere by
surprise. ‘Learning the lesson of recessions past’, postwar reconstruction
planning focused on Keynesian solutions to the slump that had caused such
hardship at the end of the First World War. Paul Samuelson (1944a, 298;
1944b, 335), the ‘father of modern economics’, was not alone in warning of the
‘serious storm’ that was ‘on the horizon’ with demobilisation and in calling for
‘a vast expansion of useful public construction’; but he could not have been
more wrong. No such slump eventuated, and planning quickly had to respond
to the opposite challenge (Whitwell 1986, 83). This ‘forecasting debacle’
(Leijonhufvud 1968, 187) was a harbinger of things to come. The limitations of
Keynesianism immediately became evident, first of all in the public works
program. The kind of massive infrastructure investments that were to form the
centrepiece of postwar countercyclical policy were imperative for social,
microeconomic and developmental reasons, but would be unavoidably and
dangerously procyclical under the unanticipated boom conditions (Whitwell
1986, 90–5). From the beginning, then, the continuing challenge was how to
contain inflation under full employment conditions rather than how to
maintain investment and jobs in a slump.
What about short-term cyclical management? Under such benign conditions
there is good reason to expect ‘fine tuning’ to have been a contributing factor
to general economic welfare. That even this was the case, however, is not so
clear. According to Whitwell (1986, 104–7), the first instance in Australia of a
deliberately and openly Keynesian countercyclical intervention was the budget
of 1951, brought down to cool a rapidly overheating economy and reduce
inflationary pressures. But the budget came too late to have the desired effect,
instead exacerbating a very sharp downturn that was already underway, and
policy had to lurch back the following year to a more accommodating stance.
Similarly, according to Whitwell (1986, 134), the failure of the mildly
disinflationary budget of early 1961 to have much impact on inflationary
THE RETURN OF KEYNESIANISM
361
pressures that were being stoked by wage increases, led to a severe fiscal and
monetary tightening in November whose ‘effect on economic activity was
abrupt and considerable and ushered in a recession which persisted well into
1962’.3
As Myrdal (1939, 187) noted, ‘fiscal policy is rather a clumsy instrument in
crisis policy when utilized as the mobile factor in fighting against depressive
forces which change from month to month and from week to week’. A clear
reason for the failure of Keynesian fine tuning in the instances Whitwell
analyses was an over-reliance on fiscal policy. Committed to a policy of cheap
money, the government had foreclosed the option of using contractionary
monetary policy earlier in the cycle to pre-empt the extremes (Bell 2004, 15;
Rowse 2002, 230–232; Whitwell 1986, 105). The underlying problem here is the
strong tendency to confuse Keynesian policy making with the use of fiscal
rather than monetary instruments. Keynes expressed scepticism about the
adequacy of monetary solutions to the Great Depression, but was not arguing
for a general approach that privileged fiscal policy (Bibow 2002; Leijonhufvud
1968; Modigliani 1977; Moggridge and Howson 1974; Sheehan 2009; Tily
2007).
Stagflation and the Death of Keynesianism?
As is well known, Keynesianism met its nemesis in the 1970s, when the
combination of slow growth, rising inflation and increasing deficits hamstrung
countercyclical fiscal policy. With an unprecedented peacetime inflation (De
Long 1997; Kaldor 1976) and slowing growth across the advanced industrial
countries, the ‘golden age’ was over. Economic downturns up to and including
the Great Depression saw inflation give way to deflation. Countercyclical fiscal
policy made eminent sense in such cycles, but was stymied by an inflationary
downturn.
Debate continues over the causes of the stagflationary difficulties and the
extent to which Keynesianism is implicated in some way or another. In some
interpretations, the ‘Great Inflation’ was driven by exogenous factors – supplyshock factors, notably the oil price rise (Ball and Mankiw 1995; Blinder 1982;
Blinder and Rudd 2010). From a Kaleckian perspective, by contrast, the Great
Inflation was fundamentally endogenous: the predictable (and predicted)
consequence of Keynesian full employment policies that generated increasing
wage pressures and a ‘profit-squeeze’ (see, for example, Marglin 1990). From
this perspective, ‘the seeds of the crisis of the 1970s were present in the
prosperity of the 1960s’ (Beaud 2001, 223). Another view also implicates
Keynesianism, but because of the bias Keynesianism gave to fiscal and
monetary policy rather than via its impact on the labour market – there was a
clear ‘toleration’ of inflation among policy makers (Leeson 2001, 100). It is a
remarkable, and telling, feature of the early 1970s that real interest rates were
close to zero and in some particularly high-inflation countries, such as
Australia, actually negative (Allsopp and Glyn 1999, 3; Gregory 1991, 111). In
respect of the United States at least, De Long (1997) has argued that loose
3
Unemployment was driven up to a peak of 3.1%, and stayed above 2% for over a year (Whitwell
1986, 137) and the government had to respond with more accommodating settings.
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A. FENNA
monetary policy resulted from a Keynesian predisposition against contractionary measures burned into the minds of a generation of economists and
policy makers by the experience of the Great Depression (De Long 1997; Mayer
1998; Romer and Romer 2002). In this view, ‘the inflation of the 1970s was an
accident waiting to happen’ (De Long 1997, 251).
The solution was tight monetary policy – adopted early, consensually and
undisruptively in Germany, later and more savagely in the United States,
but highly effective in both cases (Beyer et al. 2010; Johnson 1998). One
comparative study of the Australian experience argues that Australia’s
relatively poor record on inflation in the 1980s reflected the failure to embrace
monetarism and impose sufficiently contractionary monetary policy (Nelson
2005). Although the Accord did help moderate inflation rates during the 1980s,
its main objective and achievement was to increase growth and employment
instead (see also Bell 2004, 39–54). It was not until the recession of 1990 had
made its mark that Australia joined the low-inflation club, with rates in the 2–
3% band rather than the average of 9% that had prevailed for the previous two
decades (Edwards 2006, 31–2; Stevens 2003, 18).
Although its extreme version, what Bradford De Long (2000) calls ‘political
monetarism’, disproved itself in application, the main message of ‘classical
monetarism’ has been absorbed into mainstream economic thinking and the
practice of economic policy making. In US Federal Reserve Chairman Ben
Bernanke’s (2003) words, ‘Friedman’s monetary framework has been so
influential that, in its broad outlines at least, it has nearly become identical with
modern monetary theory and practice.’ This applies equally to Australia, where
the Reserve Bank finally adopted a coherent and determined inflation targeting
regime when the opportunity arose in the aftermath of the 1990 recession (Bell
2004).
Rebirth of Keynesianism?
As Notermans (2000) argues, left-wing parties are much better positioned in
times that call for Keynesian solutions than they are in times when price
stability is a greater issue. Thus, the global financial crisis and subsequent
recession provided auspicious conditions for the new Labor government. Active
Keynesianism – the explicit and avowed use of discretionary fiscal policy for
countercyclical demand management – quickly became the order of the day.
Within weeks of the world downturn becoming evident, the government seized
the initiative with the $10 billion cash handouts of its ‘Economy Security
Strategy’ of October 2008. Supported by Treasury’s advice to ‘go early, go
hard, go households’, the government delivered an upfront stimulus that was
designed to minimise lags and maximise impact. The need for timely response
was seen by Treasury as being the lesson of the 1990–91 recession (Gruen and
Stevens 2000). When the full seriousness of the recession became evident, this
was followed by the deficit budget and infrastructure-spending program of May
2009. From a projected surplus of 1.8% of GDP the government’s first budget
moved into a 2.7% deficit by the end of the year – a $53 billion reversal. A
deficit of 5.7% of GDP was projected for 2009–10 with substantial deficits
continuing into the forward years. Reinforcing this countercyclical fiscal policy
was aggressive interest rate cutting by the Reserve Bank.
THE RETURN OF KEYNESIANISM
363
Such a willing embrace of traditional Keynesianism was made possible by a
highly unusual confluence of conducive conditions at the level of theory, in the
economy, in the fiscal position of government, the nature of the crisis and the
international response. This is the first time since the postwar boom that there
has been consensus support for deficit spending. Domestically, this has been
most evident in the unusual degree of business support. Both the Business
Council of Australia (see BCA 2009) and the Australian Industry Group (see
Ridout 2009) endorsed a Keynesian approach. This is consistent with the urgent
recommendations of the leading international economic policy bodies, the
OECD and the IMF (Spilimbergo et al. 2008).
Contributing to this consensus was the rehabilitation of Keynesianism within
mainstream economics. For a number of leading macroeconomists, greater
specification of Keynesianism’s microeconomic logic had given the approach a
firmer theoretical basis (Akerlof 2007a, 2007b; Blinder 1988; Chari and Kehoe
2006; Mankiw 1992, 2006; Romer 1993). In the process, the ‘New Keynesians’
have revised the theory by, among other things, recognising the importance of
both fiscal and monetary instruments, taking inflation more seriously and being
more cautious about the possibilities of stabilisation policy.
This was the first major downturn since a low-inflation environment was
restored in the early 1990s. For the first time in decades, it became possible to
reflate without reigniting inflation. In addition, having inflation under control
has allowed fiscal policy to function in concert with monetary policy, with very
low interest rates around the world supporting expansionary fiscal policy
(OECD 2009b, 44). The economy also was maximally obliging as far as timing
is concerned: with advance signals coming from the growing crisis in the
financial sector overseas; the IMF (2008) announcing as early as April an
impending global downturn; the collapse of Lehman Brothers in midSeptember confirming the seriousness of events; and the low risk of an
immediate recovery, with the IMF (2009b, xv) warning over a year later against
‘premature exit from accommodative monetary and fiscal policies’. And fiscal
conditions were equally auspicious. In addition to changing economic
conditions, the greatly improved budgetary position of governments across
the OECD had helped reinstate Keynesian fiscal policy – not least of all in
Australia (Fenna 2007).
But what to spend that money on? Here, again, circumstances were
conducive. Calls to reverse the trend towards pro- rather than countercyclical
public works spending by reviving the notion of an ongoing ‘ready shelf’ of
capital works proposals (see, for example, Hughes 2001) reflected a broad sense
that Australia’s capital stock had been neglected through years of fiscal
tightening. The incoming Rudd government had already made largescale infrastructure investment a priority; funds had been set aside; the
government was working through its revived model of cooperative federalism
to inject substantial investment through the States into major transportation
projects; and an infrastructure advisory body had been established (Albanese
2008).
Finally, there has been the most benign external environment ever faced by
the Australian economy in a recession. The coordinated and comprehensive
response of the world’s major economies meant that Australia stood to benefit
from a ‘global Keynesianism’. The contrast between that coordinated
364
A. FENNA
international response and the beggar-thy-neighbour policies of the 1930s
could not be starker. And it was not just the advanced economies. China
responded to decline in demand for its manufactured exports by implementing
a very large-scale Keynesian program of steel-based infrastructure investment.
Australia benefited thus not just from the global Keynesianism but, most
particularly, from the fact that the usual collapse in demand for its resource
exports did not occur; this was the decisive factor in Australia’s outstanding
success. Although the advanced economies in general experienced an 11.7%
fall in exports in 2009, Australia’s exports grew by 0.6% (Treasury 2010). The
extraordinary rise in Australia’s terms of trade of the past few years was
briefly arrested, but only briefly; within months the minerals boom was back
on and the talk was again of skills shortages. Again, the contrast with the
1930s could not be greater.
Results
Judging by the results, Australia’s born-again Keynesianism has been a great
success; as one of only three OECD countries to avoid recession, Australia’s
performance has been outstanding. In the government’s view, this was the
result of public spending, ‘contributing around 2 percentage points to annual
GDP growth’ (Treasury 2010). In the previous year’s Budget Papers, when the
emphasis was on justifying the budget blowout rather than celebrating its
success, Treasury noted, however, that a good part of the stimulatory deficit
was entirely involuntary – deriving automatically from the downturn’s
widening scissors effect of declining tax take and rising transfer payments.
Indeed, the 2009 Budget Papers estimated that fully two-thirds to threequarters of the ‘deterioration in the budget position’ was to be accounted for
this way (Treasury 2009). Thanks to the ‘automatic stabilisers’, any modern
budget has Keynesian qualities under these circumstances unless governments
take deliberate action to neutralise or moderate their effects (van den Noord
2000; also Darby and Melitz 2008). Most economic analysis points to the
automatic stabilisers as not only making a substantial contribution to
macroeconomic management, but as being, in most circumstances, a better
tool than the discretionary fiscal policy that is often thought of as being what
Keynesianism is about (Hemming, Mahfouz and Schimmelpfennig 2002;
Taylor 2000). Ultimately, this points the way to propositions that Australia
adopt a more cybernetic approach to macroeconomic fiscal policy, insulating
it from the political process a là monetary policy (BCA 1999; Gruen 1997,
2000).
The challenge of an active countercyclical public investment strategy has
always been appropriateness and timeliness. Keynes advocated public works
in a period when there was all too little danger of being caught out by a
rapid recovery. Although measures such as the October 2008 stimulus
package have the great advantage of taking immediate effect, using
infrastructure investment as a countercyclical tool is enormously more
challenging. Major capital works can easily take years from conception to
full-scale construction. This is even more the case if, as the OECD (2009a)
enjoins, they only proceed after being ‘carefully’ selected on the basis of
cost–benefit analysis – for they must also be sound expenditures in their own
THE RETURN OF KEYNESIANISM
365
right.4 Keynes ([1931] 1972, 139) verged on the reckless in this respect,
suggesting in all seriousness that the government ‘pull down the whole of
South London from Westminster to Greenwich’ and rebuild it as a public
works project. There has been ample evidence that the Rudd government’s
capital works spending on home insulation and school building has been
compromised by the urgency. However, from a macroeconomic perspective,
the main problem has been the perennial one of mistiming. The greatest part
of the ‘Building the Education Revolution’ construction projects simply
failed to get underway until the recession was over (Auditor-General 2010,
15–16).
Conclusion
Keynesianism’s enduring attraction lies in its promise that we can assert
democratic control over one of the most important aspects of the capitalist
economy – the supply of jobs. There is broad consensus that an international
willingness to implement strong countercyclical fiscal policy was instrumental in
averting an economic crisis of Depression-like dimensions in 2009. Under the
Labor government, Australia led the way in that initiative and performed
exceptionally. This paper has argued that only a highly unusual set of
circumstances made Australia’s discretionary deficit spending look as appropriate and effective as it was.
Critics such as Hay (2007) or Bell (2000) promote the idea that being
Keynesian means spending one’s way to full employment and that anything less
is evidence of a putative ‘neoliberalism’. This is the fallacy of ‘fiscalism’ – the
‘myth’ (Sheehan 2009, 246) that Keynesianism is defined by a fiscal, rather than
a monetary, approach to countercyclical demand management and the use of
fiscal stimulus, regardless of potentially adverse effects. This sort of myth has
been sustained by another set of myths about the lessons to be learned from
recessions (and economic booms) past. In particular, the sort of lessons from
the Great Depression that the Prime Minister called upon to justify his
government’s energetic fiscal policy would seem to be entirely mythical in both
the colloquial sense of being only tenuously connected to reality, and in the
technical sense of being a symbolically powerful interpretation of the past
constructed to serve particular purposes in the present. If there are lessons to be
drawn from Australia’s experience in the Great Depression – other than to tie
oneself economically to a rising rather than a declining power – they are about
the importance of starting from a strong budgetary position and following
appropriate monetary policy.
Keynesianism is about calibrating monetary and fiscal policy to favour full
employment in the short term without creating lasting problems of debt or
inflation. It entails investing in fiscal stimulus in conditions where substantial
economic resources, both capital and labour, are idle; inflationary dangers are
4
This is redolent of Myrdal’s (1939, 193–4) otherwise very strong endorsement of his
government’s deficit-spending program in the early 1930s. ‘Public works were generally begun
too late; they were not prepared in advance and were, for this reason, delayed and scarcely aimed
at the works which should have been selected before all others if a rational choice had been made.
They were usually of much smaller scope than would otherwise have been desirable.’
366
A. FENNA
minimal; and current account problems do not threaten. Commitment to
balancing the budget over the cycle is in no way contrary to Keynesianism and,
indeed, is integral to Keynesianism-in-practice, as emphasised by Myrdal.
Deliberate deficit spending to provide demand-side stimulation is the epitome
of Keynesianism, but it is by no means everything that Keynesianism is about
or implies.
Conveniently for a party of the Left, the Rudd government came to office
when an unusual combination of fiscal and economic circumstances made such
classically Keynesian methods applicable once more: public debt had been
retired; inflation rates were low; other, larger countries were following suit; and
infrastructure backlogs beckoned. Ultimately, though, China’s success in
maintaining its apparently insatiable demand for Australian resources was the
key to Australia’s performance. The reality is that Keynesianism was developed
as an alternative to procyclical policies in an era of deflation. There has been no
deflation in this crisis and with the automatic stabilisers, there is little or no
danger of perversely procyclical budgeting occurring. Discretionary deficit
spending has been feasible for the first time in a long time, but given its limited
impact, contribution to debt, administrative problems, waste and inefficiency,
and inevitable lags, it may not have been advisable.
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