Only Keynes’s animal spirits can intoxicate our hung-over economies
Neither increased government spending nor austerity can solve the world economy’s problems on their own. We must give entrepreneurs a reason to rediscover their exuberance

  • John Llewellyn
  • reprinted with permission from The Observer, where it was published 22 August 2010

John Maynard Keynes at home in London, 1940. Photograph: Corbis
It was Joan who set me straight. Joan Robinson. Joan, who, as a young academic in Cambridge, had sat each evening at the feet of John Maynard Keynes. Joan helped me back in 1970.
I was experimenting with indicators of consumer and business confidence to see whether they could improve the ability of Wynne Godley’s models of the British economy to track the data of the day. When Joan asked what I was doing and I told her, I was nonplussed when she replied that it was “not the point”.
“Confidence indicators tell you only about the present,” she said, “and that is not very important.” What Maynard was concerned about, she went on, was “animal spirits” – the optimism of businessmen to borrow and spend today, even though the resulting output can be offered for sale only in a future that is intrinsically unknowable.
While Joan’s riposte struck me forcibly, I did not for many years fully take her point. Today, however, I appreciate that what Joan was trying to get into my head was, and remains, of fundamental importance.
Every year, households and companies save part of their income. That saving has to be borrowed and spent, otherwise the economy slides into recession. But borrowing has to be paid back, and with interest, so it had better finance investment, rather than mere consumption.
Hence the fundamental significance of animal spirits. As Joan explained, entrepreneurs may be “confident” that their revenues will continue to exceed their costs. But that does not mean they will feel sufficiently spirited to expand capacity. That requires faith that, in the unknowable future, demand will be higher than at present.
That is broadly the situation in most western economies today. In aggregate, the corporate sector is in no mood to borrow on the scale needed to ensure that the economy’s full rate of saving gets spent.
In response, governments have stepped in to fill that borrowing and spending “hole”. By so doing, they are preventing demand from falling. But while it is currently easy for governments to borrow – to sell bonds – the resulting levels of debt will eventually worry investors. Then, as in the early 1980s, governments will have no option but to tighten fiscal policy. And that damages demand: 1982 saw zero growth among members of the OECD for the first time in its history.
OECD governments must therefore do what they reasonably can to inculcate the belief that the future will be a good one. But here opinion is divided. While it is too soon to be sure how much fiscal tightening each government will actually do, the rhetoric differs from country to country.
US policymakers judge that animal spirits are best maintained by keeping aggregate demand as high as possible near term. That is understandable. Americans fear depression – in the Great Depression, US output fell, peak to trough, by a staggering 30%, more than in any other country.
Reassuring continental Europeans, however, particularly Germans, about the future is likely to involve promising them that the state finances will remain sound, even if at the risk of weakening demand. That too is understandable. It was hyperinflation, not the Depression, that so fundamentally seared the German psyche.
So what of the UK? Are Britons more like Germans, or Americans? Probably, as in many cultural matters, they are in between, in which case UK political rhetoric, which places more emphasis on deficit reduction than in the US, but less so than in Germany, is understandable.
It is a pity that Joan is not alive today to talk to those who, in analysing a world that is increasingly globalised in trade, make the mistake of thinking that it also has a globalised culture. A full and proper recovery, when it comes, will happen because entrepreneurs’ animal spirits are rejuvenated. The most that governments can do meanwhile is draw the best possible balance between supporting demand today and delivering a sound fiscal position tomorrow.
John Llewellyn is a partner in Llewellyn Consulting, was global chief economist at Lehman Brothers, and one-time head of economic forecasting at the OECD

Your editor has a personal crisis this morning and will file her daily blog for paid subscribers later today. Meanwhile I have posted something for our readers, all and including pre-subscribers, to ponder. The author is a New Zealander who sent me his article and got me permission to reprint it from The Observer, a British Sunday newspaper.