Keynesian Theory to Overcome Pandemic-hit Economy

Nironjan Roy

17 February, 2021 12:00 AM printer

At the beginning of last year, when COVID–19 pandemic engulfed the whole world, economists, experts, think tank and policymakers became bewildered how to save the people. Economic reality and people’s lives emerged as confronting situations to the world-leaders, policymakers and economists who had been scrambling hard to save both. Without having the scope of much deliberation and analysis, governments of almost all countries irrespective of developed and developing status, had to immediately respond with some drastic measures including massive financial stimulus based on recommendation made by renowned economists and think tank.

Many economists and financial experts strongly advocated for providing financial support to the people and business communities resorting to massive deficit finance if necessary. Even, Nobel laureate Bengali economist, Avhijit Banarjee, has also come up with recommendations of ensuring disposable money among the people. In an interview with a Bangladeshi TV Channel at the beginning of the pandemic, MIT professor, Abhijit Vinayak Banarjee has urged the government of Bangladesh and India to make money supply available among the people of the country, even if necessary by circulating (printing) currencies. He has categorically mentioned that providing people with disposable money will increase aggregate demand in the economy which will, in turn, keep the country’s economic growth up. 

This idea is not new at all:  Recommendation of ensuring money supply among the people is not a new economic policy at all; rather the capitalist world has been pursuing this monetary policy for the last hundred years. In 1930 when the world fell into great depression and world-leaders were scrambling hard to find an appropriate solution to rescue the world economy, British economist, John Maynard Keynes came up with this theory of raising people’s purchasing power by means of available money supply which would increase aggregate demand in the economy. According to Keynesian theory, when there is a shortage of aggregate demand in the economy, there prevails high unemployment which causes prolonged recession in the country. His economic theory is based on the idea that when aggregate demand is increased, more investment is required in order to meet the increased demand and more investment generates more employment opportunities which eventually creates more demand for goods and services in the economy. With the continuation of this economic cycle, the country's aggregate demand continuously increases till the economy reaches full employment and thus, the economy is recovered from recession. 

Keynesian theory is still an effective economic measure: Economist Keynes strongly recommended adopting fiscal policy which increases peoples’ purchasing power which almost all developed countries adopted and thus recovered from the great depression in 1930. Economist Keynes elaborated his idea in the book titled, The General Theory of Employment, Interest and Money, published in 1936. All countries of the western world have applied Keynes's policy recommendations and almost all capitalist countries had pursued this policy by the end of two decades following Keynes's death in 1946. To speak the truth, the developed world is still pursuing this policy and no other better economic theory has yet emerged to replace Keynesian theory. However, the forms of policies and its scope of application have widened and even upgraded with the change of economic fundamentals and people’s lifestyle.

Initially people were provided with more purchasing power by dint of tax-cut or tax-return followed by introduction of hire purchase for durable consumer goods, which allows people to consume now and pay later. Subsequently use of credit cards and personal finances, particularly personal lines of credit, were introduced in an attempt to make disposable money available among the people of the developed world. Still now, these two financial products are the most popular means of providing excessive supply of money to the people of the developed world.

In addition, some financial derivatives have been introduced during the last thirty years and these products include home-equity financing, education loan, employment loan, auto-loan, refinancing on asset appreciation, etc. which also increase people’s purchasing power. These financial products developed based on Keynesian theory ensured a maximum amount of disposable funds among the people and thus brought about revolutionary changes in socioeconomic conditions of the developed world where a consumption-based society has emerged and people learnt to maintain luxurious lifestyles with borrowed money.

In the developed world, per capita household debt which excludes home-loan / mortgage loan has risen to more than 100 per cent and even in some countries, this rate is about 150 per cent. Household debt is so high in these countries that about thirty to forty percent people will not be able to repay their debt in their lifetime according to many financial analysts and research bodies. Nevertheless, these developed countries follow Keynesian theory of increasing aggregate demand in the economy by way of ensuring enough disposable money among the people through issuance of credit cards, personal lines of credit and other financial derivatives. Whenever, economy falls into crisis or recession, govt. and central bank come up with financial stimulus which ensures more money supply among the people and thus increases aggregate demand which eventually helps the country recover from economic downturn. No exception is noticed even in the current economic hardship being faced by not only the developed world but also the developing countries, rather almost all countries irrespective of its status of developed or developing, have undertaken massive financial stimulus program which will help people with providing money supply so that their purchasing power can be maintained to support economic recovery. 

Money supply must correspond with economic value addition: Although Keynesian theory of increasing consumers’ purchasing power is still the only proven economic measure of recovering from economic depression, yet the policymakers have never resorted to free distribution of money to the people. Instead, they have adopted the policy which states that money supply must create value in the economy. People are provided with money for creating value in the economy either in the form of self-employment or business investment for generating employment opportunities.

Credit card or personal line of credit or other financial derivatives are basically forms of borrowing funds which the borrowers are obliged to repay and this repayment comes from income generation which is the price of the goods and services produced in the economy. Because easy money, especially free money supply, bears many negative implications to the economy and high inflation is one of them. In addition, this kind of free money supply creates an idle society because people become lazy and reluctant to work. Greece, Spain and some European countries are good examples where social security and early pension arrangement provide free money to the people who prefer playing guitar, singing and spending time at the beach to working and as a result, these countries could not fully recover from recessionary trap in spite of taking extensive financial assistance and stimulus from European central bank. 

Governments should provide for creating value addition opportunities:  Our government has also undertaken massive financial stimulus in order to face the aftermath of COVID-19 pandemic and disbursement of this stimulus package will inevitably provide adequate money supply in the economy. So far, we know financial stimulus is being provided in the form of various loans at a very cheap rate or nominal rate of interest. Even, financial stimulus earmarked for the agricultural sector is also being disbursed through loans at nominal rate. These financial measures undertaken by our government are found to be consistent with the financial stimulus declared by developed countries. Of course, there is a segment of society which is not in a position of value creation in the economy, because the country's workforce does not include this segment of society, like senior citizens, persons with disabilities, so they must be provided with money for maintaining their livelihood. Others will be provided by creating either self-employment opportunities or investment opportunities for the business community, who in turn will contribute in generating employment, thus creating value addition in the economy. In this way, the country will not only maintain sustainable economic growth but also keep the economy on the right track which proves that Keynesian theory is effective even in overcoming pandemic-hit economies.


The writer is a banker living in Toronto, Canada