How Did We Get Here Chapter 7 - Married to Keynes

HOW DID WE GET HERE

Chapter 7 – Married to Keynes

A discussion unfolds in the language of monetary policy, measured, precise, and carefully framed to suggest control. Interest rates, liquidity, and inflation targets were referenced with the quiet confidence of systems that believe themselves to be calibrated rather than constructed. Charts tracked movements that appeared manageable when contained within bands and percentages, even as their effects extended well beyond the page. Beneath it all sat an unspoken constant, a framework that shaped both the questions asked and the answers considered acceptable. 

Though rarely acknowledged directly, and often denied when raised, the influence of John Maynard Keynes lingers at the back end of the conversation, guiding the instinct to intervene, to adjust, to support. It was present not as a declaration, but as a default, embedded so deeply within the machinery of policy that its presence no longer required explanation, only continuation.

The conversation moves, as it often does, towards solutions that had already been decided before the meeting began. There was talk of targeted support, rebates designed to ease immediate burdens, adjustments that could be rolled out quickly and explained even more quickly. The language was reassuring in its familiarity. It suggested action without disruption, intervention without consequence. It was at this point that the logic began to shift, not abruptly, but in that subtle way where momentum starts to carry the discussion beyond the point where questions are asked.

No one paused long enough to sit with the contradiction. The same economy described as overheated was being offered more fuel, albeit carefully measured and well intentioned. The same households struggling with rising prices were to be given additional capacity to spend, as though the act of spending were not itself part of the cycle being discussed. It was not that the room was unaware of this tension. It was simply that acknowledging it would require stepping outside the framework that had already been agreed upon.

And that framework, more often than not, finds its roots in the teachings of the aforementioned, John Maynard Keynes.

Keynesian economics, at its core, is disarmingly simple in its appeal. It begins with the observation that economies are not self-correcting in the short term, that periods of downturn can persist because individuals and businesses, acting rationally in isolation, collectively reduce spending. When everyone tightens, demand falls. When demand falls, production slows. When production slows, employment suffers. The cycle feeds on itself, not because of malice or error, but because of a series of individually sensible decisions that combine into a collectively damaging outcome.

What sat beneath Keynes’ thinking was a framework that attempted to capture this behaviour in a way that could be understood, measured, and ultimately influenced. The economy, in its simplest expression, could be described as the sum of what was being spent. Not what was being produced in theory, not what could be produced under ideal conditions, but what was actually being purchased in real time. That idea found its way into a deceptively straightforward relationship:

Y = C+I+G+(X-M)

The output is the sum of spending categories

In this expression, total economic output, represented by Y, is broken down into its component parts. There is consumption, C, which captures what households spend. There is investment, I, reflecting what businesses commit towards growth, expansion, and future production. There is government spending, G, the direct intervention of the public sector into the economy. And finally, there is the balance of trade, X−M, exports minus imports, representing the interaction with the rest of the world.

On the surface, it reads almost too simply. The economy is just spending, broken into categories. Yet the power of the idea lies in what it implies rather than what it states. If total output depends on total spending, then a reduction in any one of these components has a direct impact on the whole. More importantly, if one component falls sharply, the others must either rise to compensate or the economy contracts.

This is where Keynes departed from the idea that markets would naturally and quickly correct themselves. If households reduce consumption because of uncertainty, and businesses reduce investment because of falling demand, the two largest components begin to shrink at the same time. The formula does not rebalance itself automatically. Instead, it reflects the contraction as it happens. The numbers fall because the behaviour has already changed.

The Keynesian response to this is intervention. If private demand falls, public demand must rise. Governments step in, increasing spending, lowering taxes, or both, to inject activity into the system. Within the framework of the formula, this is a deliberate adjustment to G, designed to offset declines in C and I. The aim is not to replace the market, but to stabilise it, to provide a bridge across periods where confidence has eroded.

In simple terms, if people stop spending and businesses stop investing, the government fills the gap so that businesses continue to operate, employees continue to earn, and the cycle does not spiral downward. The expectation is that, over time, confidence returns. Households begin to spend again, businesses begin to invest again, and the government can step back, having played its role in maintaining the flow.

In its intended environment, this approach has a certain elegance. It acknowledges human behaviour rather than assuming perfect rationality, and it offers a mechanism to counteract the natural tendency of fear to contract an economy. It treats the economy less like a machine that corrects itself and more like a system that occasionally needs to be steadied when its participants all react in the same direction at the same time.

The difficulty, as it begins to emerge when this framework is applied beyond its original context, is that the formula does not distinguish between types of spending, only the presence of it. It does not ask whether the additional demand is productive or inflationary, temporary or structural. It simply records that it exists. And when that distinction is overlooked, the very tool designed to stabilise the system can begin, quietly and incrementally, to reshape it in ways that were never part of the original intent.

Central banks, operating alongside this philosophy, adjust the cost of money itself. Interest rates are lowered to encourage borrowing and spending, raised to temper excess when the economy begins to run ahead of itself. The interplay between fiscal policy, driven by government spending and taxation, and monetary policy, driven by interest rates, becomes the toolkit through which modern economies are managed.

In theory, it is a system of balance. When demand is weak, support is provided. When demand is strong, restraint is applied. The difficulty, as it quietly emerges in rooms like the one described, is not in the theory itself, but in the application of it over time.

Because while Keynesian economics provides a clear answer to downturns, it is far less comfortable in periods of simultaneous inflation and stagnation. The condition often referred to as stagflation sits awkwardly within the model, not least because it forces a closer look at the language used to describe how an economy is performing. Terms like “output” and “growth” are presented as objective measures, clean and measurable, yet they carry with them assumptions that often go unexamined.

Output, in its simplest sense, refers to the total value of goods and services produced. It is the number that sits behind the broader narrative, the figure that feeds into reports and headlines. Growth is the movement of that number over time, an increase in output that is interpreted as progress. Governments lean heavily on this word. Growth suggests forward motion, improvement, a sense that things are getting better. It is used as both a descriptor and a justification, a way of framing policy decisions as necessary steps towards a larger goal.

Inflation complicates this picture. Prices rise, and with them, the measured value of output. An economy can appear to be growing because the dollar value of what is being produced is increasing, even if the actual volume of goods and services has changed very little. The distinction between nominal growth and real growth begins to matter, yet it is not always the distinction that leads the conversation. The headline number still moves upward, and with it the suggestion of success.

Stagnation, by contrast, speaks to the absence of meaningful progress beneath those numbers. Real output, adjusted for inflation, slows or flatlines. Productivity stalls. The capacity of the economy to produce more, to improve living standards in a tangible way, begins to weaken. Yet when inflation is present at the same time, the language of growth can persist, creating a disconnect between what is being reported and what is being experienced.

Stagflation brings these contradictions into focus. Growth, as presented, may still exist in nominal terms, while real output struggles to advance. Prices rise, eroding purchasing power, even as the narrative continues to point towards expansion. The reliance on aggregate measures begins to obscure as much as it reveals. It allows the conversation to continue in familiar terms, even as the underlying conditions diverge from what those terms were meant to represent.

Within this environment, the Keynesian instinct to support demand becomes more difficult to apply with confidence. Increasing spending may lift output in nominal terms, reinforcing the appearance of growth, but if the economy’s ability to produce is constrained, the result is more likely to be higher prices than higher real output. The numbers move, the language of growth remains intact, yet the substance behind it becomes harder to defend.

And so the question shifts, not just towards which levers are being pulled, but towards how success itself is being defined. If growth can be claimed in the presence of rising prices and stagnant real output, then the measure has begun to drift from the reality it was meant to capture. The framework continues to operate, the terminology remains consistent, but the connection between the two becomes increasingly tenuous, leaving a lingering uncertainty as to whether the system is being guided by what is happening, or by how it is being described.

This is where the modern interpretation begins to drift from the original intent. The political appeal of stimulus is undeniable. Providing support is visible, immediate, and easily communicated. It aligns with the expectation that something must be done, and done quickly. The cost, particularly when spread across future budgets and abstracted through borrowing, feels distant. The benefit, delivered through rebates and assistance, feels immediate.

Over time, this creates a subtle shift in behaviour, not just within governments, but within the broader system. Intervention becomes not a tool of last resort, but a default response. The idea that demand should be supported becomes detached from the conditions under which that support was originally intended. It evolves into an assumption that any pressure within the economy can be eased through additional spending.

At the same time, central banks continue to operate within their own framework, adjusting interest rates in response to inflationary pressures. Yet the reach of these adjustments is uneven. Interest rates primarily affect those exposed to debt, particularly households with mortgages and businesses reliant on borrowing. Large segments of the economy remain relatively insulated, while others bear the brunt of the adjustment. The result is a narrowing of impact that sits uncomfortably alongside the broad-based nature of the problem.

The meeting, in this context, becomes less about exploring alternatives and more about reinforcing a shared understanding. The language used does not invite challenge; it manages perception. Terms like “targeted relief” and “measured response” create the impression of precision, even as the underlying dynamics remain largely unchanged. The idea that increasing financial support in an inflationary environment might contribute to the very pressure being addressed is acknowledged only in passing, if at all.

This is where the “think it therefore it is” phenomenon begins to take hold. The repetition of the framework, the consistency of the language, and the alignment of incentives all contribute to a version of reality that feels stable because it is familiar. The possibility that the approach itself may need to be reconsidered becomes increasingly difficult to articulate, not because it lacks merit, but because it sits outside the accepted narrative.

Mob mentality, in this setting, does not present as overt agreement. It appears in the absence of dissent. It is found in the small decisions not to interrupt, not to question, not to pursue the line of thinking that might complicate the discussion. Each participant, aware of the broader context, weighs the value of introducing friction against the cost of maintaining alignment. More often than not, alignment wins.

There is an almost farcical quality to it when observed from a distance. A system designed to respond dynamically to changing conditions begins to respond predictably regardless of those conditions. Inflation rises, and support is provided. Interest rates rise, and the same support is maintained. The two forces, operating in parallel, begin to resemble a carefully choreographed dance where each step is technically correct in isolation, yet collectively leads nowhere in particular.

From a political standpoint, this is where the line between appearing to do the job and actually doing it begins to blur. Action is visible. Announcements are made. Relief packages are framed, debated, and delivered. Central banks adjust rates with the seriousness that such decisions demand. Each movement can be pointed to as evidence that something is being done, that the machinery is active and responsive. Yet the question that rarely sits long enough in the room is whether these actions, taken together, are resolving the issue or simply maintaining the appearance of resolution.

The appeal of this approach is not difficult to understand. Providing support to those under pressure is both necessary and politically resonant. It signals care, responsiveness, and an alignment with the immediate concerns of the electorate. At the same time, allowing central banks to tighten monetary policy creates the impression of discipline, of control being reasserted over inflationary forces. Both narratives can be sustained simultaneously, even as they begin to work against each other beneath the surface.

The uneven reach of these tools only adds to the effect. Changes in interest rates, for all their prominence in economic discussion, directly impact a relatively narrow portion of the population. Those carrying debt, particularly mortgage holders and leveraged businesses, feel the adjustment almost immediately. For many others, particularly those without significant borrowing, the effect is far less direct. The burden of monetary tightening is therefore concentrated, not distributed. It presses most heavily on a segment often described as the middle, those with enough exposure to feel the change, but not enough insulation to absorb it without consequence.

At the same time, fiscal measures are directed towards easing cost-of-living pressures, often focused on those at the lower end of the income spectrum. The intent is clear, to provide relief where it is most needed, to soften the immediate impact of rising prices. Yet when these measures are layered over a tightening cycle that disproportionately affects another group, the system begins to reveal an uncomfortable imbalance. One hand provides assistance, the other applies pressure, and the two rarely meet in a way that resolves the underlying tension.

The result is a structure that can be defended at every point, yet questioned in its entirety. Each decision, taken on its own, aligns with a version of the theory. Support those who need it. Control inflation. Maintain stability. But when viewed collectively, the pattern suggests something else, a reliance on visible action as a substitute for effective coordination. The system continues to move, the signals continue to be sent, but the direction becomes increasingly difficult to define.

It is in this space that the distinction between performance and outcome becomes most apparent. The performance is convincing. It is detailed, responsive, and constant. The outcome, however, is less certain, shaped not just by the actions taken, but by how those actions interact. And when those interactions are not fully reconciled, the dance continues, technically precise, carefully executed, and quietly circular.

The logical bystander does not need to dismantle Keynesian theory to see the issue. The theory itself is not the problem. It is the rigidity with which it is applied, the reluctance to adapt its principles to conditions that sit outside its original scope. It is the assumption that because a framework has worked in certain contexts, it must therefore be appropriate in all contexts.

Where this rigidity becomes most visible is in who ultimately carries the weight of that application. The practical levers used to influence demand tend to settle on the same group, the middle. Monetary policy, through interest rates, leans heavily on those with mortgages and business debt. Fiscal policy, through targeted relief, is often directed towards those at the lower end of the income scale, where the political and social imperative to provide support is strongest. Between these two sits a cohort that becomes both the mechanism and the buffer, absorbing pressure on one side while indirectly funding relief on the other.

There is an underlying logic to this, at least within the traditional Keynesian lens. The middle class represents a significant portion of consumption. Their spending patterns are broad, consistent, and responsive to changes in cost. Influence them, and demand can be adjusted with a degree of predictability. Yet over time, this approach begins to resemble less a calibrated intervention and more a default setting. The same group is repeatedly relied upon to carry the adjustment, not because it is always the most effective option, but because it is the most accessible.

At the same time, a different part of the equation remains comparatively untouched. Large corporations, operating at scale, continue to generate significant profits, often insulated by global structures, pricing power, and the ability to pass on increased costs. Their role within the economy is substantial, not just in production but in shaping price levels and influencing inflationary pressure in their relentless pursuit of profits and returns to shareholders. Yet the policy focus rarely settles there with the same intensity. The conversation around taxation, particularly in relation to how these profits are captured and redistributed, tends to move more cautiously, constrained by concerns around competitiveness, capital flight, and political resistance.

This creates a subtle imbalance in how control is exercised. If demand is the variable being managed, and if profit concentration at the upper end contributes to that demand in ways that are less sensitive to traditional levers, then the absence of meaningful engagement with that segment becomes harder to justify. The system continues to operate as though adjusting household behaviour will be sufficient, even as a growing share of economic influence sits elsewhere.

It is not that taxation alone provides a simple answer. The dynamics of global capital, investment incentives, and economic competitiveness are real and complex. But the reluctance to fully engage with these factors, to consider whether a more balanced approach might distribute both responsibility and impact more evenly, reflects the same rigidity that underpins the broader application of the theory.

The result is a framework that appears complete on the surface, yet uneven in its execution. The middle class becomes the primary instrument through which adjustment is made, while other areas remain comparatively static, not because they lack relevance, but because they are more difficult to address within the existing narrative. And so the system continues to apply pressure where it can, rather than where it might be most effective.

Which brings the question back, not to the validity of the theory itself, but to the choices made in its application. If the tools are known, and the outcomes are understood, then the issue is no longer one of knowledge, but of willingness. Willingness to expand the frame, to challenge the defaults, and to consider whether the balance being struck is one that serves the system as a whole, or simply sustains the path it has already taken.

A different approach does not require abandoning intervention altogether. It begins with a more deliberate examination of the conditions at hand. If inflation is being driven by excess demand, then adding to that demand, even with the best of intentions, must be questioned. If interest rate adjustments are placing disproportionate pressure on a subset of the population, then the effectiveness of that tool, in isolation, must be reconsidered.

More importantly, it requires creating space within those rooms for genuine challenge. Not the performative questioning that reinforces the existing narrative, but the kind that introduces uncertainty. What assumptions are being carried forward without examination? What outcomes are being prioritised, and at what cost? What would it look like to step outside the established framework, even temporarily, to test whether a different path might lead to a different result?

These are not comfortable questions, and they do not lend themselves to immediate answers. They disrupt the flow of meetings that rely on momentum to maintain direction. Yet without them, the cycle continues, not because it is correct, but because it is consistent.

And so the charts will continue to be presented, the language will remain reassuring, and the solutions will arrive, fully formed, before the conversation has had a chance to challenge them. The system will move forward, adjusting at the edges, confident in its ability to manage what it has already defined.

All the while, the question lingers, not loudly, but persistently.

How did we get here, and what would it take to not end up here again?