When Keynes wrote “The General Theory of Employment, Interest and Money” in the mid-1930s, governments in most wealthy nations were relatively small and their debts modest. Deficit spending and pump priming were plausible responses to economic slumps. Now, huge governments are often saddled with massive debts. Standard Keynesian remedies for downturns — spend more and tax less — presume the willingness of bond markets to finance the resulting deficits at reasonable interest rates. If markets refuse, Keynesian policies won’t work.He's really suggesting a different approach to teaching macroeconomics. The last time I thought seriously about macroeconomics was in graduate school, when Ed Feige, a Milton Friedman student, introduced us to G - T = , the government budget constraint. That's the law of conservation Mr Samuelson is referring to, noting that deficits must be Monetized or Borrowed. Somehow we got through the income-expenditure model and an entire semester of public finance and fiscal policy without encountering that law of conservation, or at best being informed that large-country governments had pretty good lines of credit.
From what little I know about the teaching of introductory macroeconomics these days, the permanent income hypothesis (which makes the multiplier based on the marginal propensity to consume go away) and rational expectations and monetary policy. These all strike me as somewhat more challenging concepts compared to the government budget constraint, and a relatively simple law of conservation ought to be easier to teach.
Countries then lose control over their economies. They default on maturing debts or must be rescued with loans from friendly countries, the International Monetary Fund (IMF), government central banks (the Federal Reserve, the European Central Bank) or someone. There are other reasons why Keynesian policies might fail or be weakened. But they pale by comparison with the potential veto now posed by bond markets. Ironically, the past overuse of deficits compromises their present utility to fight high unemployment.Here Mr Samuelson is channelling Milton Friedman, who once compared the use of inflationary policy to drink: the longer the binge, the bigger the hangover.
Governments have ceded power to bond markets by decades of shortsighted behavior. The political bias is to favor short-term stimulus (by lowering taxes and raising spending), which is popular, and to ignore long-term deficits (by cutting spending and raising taxes), which is unpopular. Debt has risen to hazardous levels, undermining Keynesian economics as taught in standard texts.The U.S. Treasury, however, is in the enviable position of selling industrial volumes of the closest thing to a risk-free security (something apparently so desirable that Hot Money was willing to invest in mortgage backed securities during the years the federal budget was in surplus) which suggests the reckoning could still be avoided, or else when it comes, it will be particularly severe.
Were Keynes alive now, he would almost certainly acknowledge the limits of Keynesian policies. High debt complicates the analysis and subverts the solutions. What might have worked in the 1930s offers no panacea today.