Keynesian Economics Concept of Bailing an Economy Out of Recession

Keynesian EconomicsKeynesian Economics revolves around the concept of using economic stimulus (ie. inflation) to bail a declining economy out of recession, and then reducing spending during more prosperous times. Without arguing the practical legitimacy of such a policy, its relevance to today’s economic environment goes without contest. As governments around the world devalue their currencies through inflation and use the proceeds to stimulate economic growth, we continue to see balance sheet sizes increase relative to their actual GDP.

While the actual productive implications of these policies are still up to debate, there is one important aspect of the trend that remains clear: governments are approaching the end-point of their ability to continue making payments on the debts that they are issuing. Known as the ‘Keynesian Endpoint”, when governments have payments to service debt that is greater than their revenues from taxation, they become physically unable to pay off their debts (similarly to a household that has credit card bills that are higher than its monthly income point). As governments continue their stimulus policies into the decade, it will be interesting to see how it is that even the smallest of hiccups in the greater macroeconomic environments could be enough to push them past this brink before they are ready for it, and how it is that it will force them to adapt.

Looking at how it is that government debt levels are currently taking up aspects of their respective incomes, we can start to come up with a variety of scenarios that might trigger a Keynesian end-point scenario. Specifically, we want to determine what sort of events would cause interest payments to exceed 100% of tax revenues, which could be caused by an increase in the interest rates associated with those debts (ie. the rate at which these debts must be issued at going forward), or a decrease in tax revenues as a result of decreased GDP from industry. Of particular note throughout this analysis is then the way in which any growth (or even stability) in GDP levels will not be a valid indication of a government’s ability to continue paying its debts because of the way in which this figure will be artificially inflated by the government spending that is taking place as a result of the higher debt-loads.

As such, industrial production, and therefore the tax revenues that come in as a result of it, must be measured as a function that excludes GDP that arises as a result of government spending. Because of the way in which this new figure is then much smaller than reported GDP, we come to a situation where it is that the most likely situation to cause a Keynesian End-Point scenario for most governments today is a change in the effective interest rate that they must pay for their debts.

While government debts are all issued at fixed rates, and are therefore not impacted by increasing interest requirements from investors over time, it is important to notice that rates go up when governments take out additional debts to continue making payments on their existing obligations. This means that the governments that are unable to make payments on their debts will experience dramatic increases in their payment obligations if they find themselves in a situation where they need to ‘kite’ their debts with additional issuances.

Today, we are seeing such a situation in places like Japan, where the largest purchaser of government bonds is actually the government, and the funds being used to purchase these debts are being generated by shorter term issuances that have slightly higher interest rates. As this trend continues, Japan is forced into a progressively worse financial state, and continues to approach its Keynesian End-Point as quickly as it can re-issue its own obligations. Specifically, Japan will reach would reach its end-point today if it were to see a 2.5-3.5% increase in its real interest rate obligation. While this amount won’t seem like much, as government debts don’t usually move by that much all at once, it is a feasible increase across the yield curve.

Looking at the Japanese example, we can come to a general conclusion that governments shortening the term of their debt-issuances in order to kite their payments can create a Keynesian End-Point scenario in the way in which these shorter-term issuances will actually increase their payment obligations by enough to actually trigger a problem.

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