The Keynesian cure entails government spending financed by taxation or borrowing to restore Mr. Economy’s health. There is no evidence that it can arrest long-term declines in growth.
Government spending boosts activity temporarily, but may create excess capacity in the absence of underlying demand. Nostalgia for President Franklin Roosevelt’s infrastructure projects during the Great Depression is misplaced. Excess electricity generation capacity from dam projects was only absorbed by wartime demand for defense equipment.
Having reduced interest rates to zero, central banks are giving Mr. Economy the Monetarist cure, changing the quantity of money available. They buy government bonds, injecting money into the banking system (QE or quantitative easing) to lower borrowing costs and increase the supply of money to stimulate demand and inflation.
Mr. Economy’s faith healers argue that central banks can keep rates low and print money to finance government debt purchases indefinitely. In recent years, the Federal Reserve has purchased around 60%-70% of all U.S. government debt issued. The European Central Bank is now financing governments indirectly by lending to banks to purchase sovereign bonds.
Greater government spending, lower rates and increased supply of money may not boost economic activity. Crippled by existing high levels of debt, low house prices, uncertain employment prospects and stagnant income, households are reducing, not increasing, borrowing.
For companies, the absence of demand and, in some cases, excess capacity, means that low interest rates are unlikely to encourage borrowing and investment.
Read more: Mr. Global Economy’s delusional mental state - Outside the Box - MarketWatch
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