John Maynard Keynes, the British economist whose theories dominated the industrial postwar West, argued for government spending as a means to counteract slow economic growth. Especially during a recovery from a recession or depression, he reasoned, private demand is insufficient, so extra spending by government is needed to ensure that aggregate demand remains high enough to maintain full employment. But what would Keynes have made of the debate over governments borrowing to invest in times outside acute crises or recession?

The cash hoarding that he predicted is evident in the post-crisis economy.

Since Keynes believed that the normal tendency was for the propensity to save to be stronger than the incentive to invest, he was supportive of governments borrowing to invest. He believed the economy usually operated below its potential, and that public investment should therefore supplement private investment.

His idea was to use fiscal policy to maintain a high level of public or semi-public investment. Investment should encourage consumption by raising the overall level of output, and thus raising income. The more consumption there was, the higher the national income, and therefore the greater the savings of the society that could be used to finance investment. A permanently high level of publicly directed investment would offset fluctuations in private investment, and contribute to the economy remaining in a “quasi-boom”.

Keynes expected the government to take on a greater role in investment as the need became clearer. His notion of “socializing investment” may well encompass a government-backed infrastructure bank or fund to help get projects off the ground. He might not have viewed private sector participation as necessary, but would have been willing to include private investors who would pool their money with the government to build infrastructure.

The suspicion that this policy would lead to persistent budget deficits was one of the criticisms of Keynes. It’s why governments have historically been reluctant to borrow to invest: they fear that bond investors will ask for higher returns to lend them money, increasing the borrowing costs for a country, which could in turn jeopardize its economic growth.

The verdict on Keynes’s vision today is far from settled. The Chicago school of monetarists say that his counter-cyclical policies are bound to fail since their effects will be anticipated, either immediately or after a short lag. The influential Harvard economist Robert Barro argues that future tax rises to pay for government deficit spending are figured into long-term interest rates by investors and savers. This process will lead to higher rates in the future and make government borrowing more expensive and the budget deficit less affordable.

The Keynesian Cross: output is on the Y axis, with spending on the X
The Keynesian Cross: output is on the Y axis, with spending on the X
Image: The Expenditure-Output (or Keynesian Cross) Model

The view can be traced all the way back to the 19th-century British economist David Ricardo. Under Ricardian equivalence, rational people know that the government debt will have to be repaid at some point in the form of higher taxes, so they save in anticipation and do not increase current consumption that boosts growth.

Still, the perceived need to increase investment and economic growth during our current struggles has shifted the public debate closer to what Keynes advocated even during non-crisis times. There is also a growing inclination to separate capital from current spending in government accounts, so that investment doesn’t count the same as day-to-day public spending.

Given the debate over low investment, the record low borrowing costs and our concerns over growth, Keynes’s lesser-known views on public investment could have a greater impact on the structure of an economy than his better-known arguments about government deficit spending.

This article is an extract from Linda Yueh's book The Great Economists: How Their Ideas Can Help Us Today (Viking).