Fiscal Vaccine for COVID-19 with Professor Tony Makin

Adept Economics Director Gene Tunny caught up with Professor Tony Makin last week to discuss his recent CIS Policy Paper, A Fiscal Vaccine for COVID-19. In Tony’s words,

“the paper considers the resurgence of crude Keynesianism before highlighting risks of the fiscal legacy”.

Tony is currently a Professor of Economics at Griffith University and has previously taught at the University of Queensland, the Lee Kuan Yew School of Public Policy at the National University of Singapore and in the Australia and New Zealand School of Government (ANZSOG) program. His field of expertise is international macroeconomics and public finance and he has previously served as an economist with the International Monetary Fund and in the Australian federal departments of Finance, Foreign Affairs and Trade, The Treasury and Prime Minister and Cabinet.

To listen to the podcast, use the player below:

For the transcript of the conversation, read on. Show notes are available at this link.

Professor Tony Makin Podcast Transcript

Gene Tunny  00:00

Welcome to the economics explained podcast. I’m your host, Gene Tunny. Governments around the world are spending billions of dollars to support their economies in this time of the COVID crisis. My guest today has recently written a paper for the Australian Centre for Independent Studies, a leading Australian think tank, on a fiscal vaccine for COVID-19. The author is Professor Tony Makin of Griffith University. Tony, thanks for joining me today.

Tony Makin  00:48

It’s a pleasure Gene.

Gene Tunny  00:49

Excellent. Tony, I’m looking forward to chatting about your paper. The Centre for Independent Studies is running a programme, “Pandemic to Prosperity”, so there’s going to be a series of working papers – It’s possible that I’ll have one coming out in this series in the next couple of months. Your paper deals with the massive government response we’ve seen here in Australia. It’s a response that you’ve characterised as crude Keynesianism. So, one of the great lines from your paper is: “The paper considers the resurgence of crude Keynesianism before highlighting risks of the fiscal legacy.” Now coming out of that great statement there, there are two questions: the first is, what is crude Keynesianism? What do you mean by that? And the second one will be what is the fiscal legacy and the risks of it? So perhaps if you could start with your definition of crude Keynesianism, please Tony.

Tony Makin  01:55

Sure Gene. Look, I think of crude Keynesianism simply as the idea that if governments spend, irrespective of what they spend on – they can spend on anything – that that will stimulate the economy. And students learn this even at high school, they learned in their first year at university that big G, if you like, is a key aggregate in the national accounts: C plus I plus G plus X minus M. If you increase G, you’re going to increase big Y, that is national income. And the device that best captures the theory of crude Keynesianism is the so-called “Keynesian cross”, which many students would be aware of. And it simply posits, and it’s a device that was invented in fact, by the American Keynesian post war Keynesian Paul Samuelson – it wasn’t in Keynes book the general theory – but Paul Samuelson developed that device, the so called 45 degree diagram. And that’s often at the heart of any thinking and it motivates, implicitly, policy responses to any downturn in big Y or national income. And why I say that’s crude Keynesianism is because it leaves out money, it leaves out funds, it leaves out expectations. It leaves out those important factors that actually mitigate against the stimulus as such. They counteract once you bring in those key variables, indispensable, you can’t assume them away. And you cannot also assume away public debt that rises as a consequence of increased government spending and budget deficits and public debt doesn’t figure in Keynes’s original work the General Theory, which is very curious because when you increase public debt it has all sorts of negative ramifications. So, crude Keynesianism is, in a nutshell, that if governments spend its it stimulates output enhance employment because at the heart of, of the idea is that if you’re increasing spending, you’re increasing employment, but there’s a whole range of reasons, particularly when you look at the economy as an open economy, why that’s not necessarily going to work.

Gene Tunny  04:36

Okay. Tony, could I just ask you about John Maynard Keynes. So, Keynesianism is a doctrine that comes from John Maynard Keynes. He was a famous British economist. Born in 1883, I believe, died just after the war. And he was at Cambridge University, he was an advisor to the British Treasury, advised various Prime Ministers, worked on the financing of world war one, he was involved in establishing the international financial system after the war, he was at the Bretton Woods Conference in 1944, if I remember correctly. Now, Keynes, he was writing at a time of the Great Depression, wasn’t he? So, he had recommendations regarding what governments should do in the depression. And he was arguing that because there was a collapse in private investment, big I, and also big C, the consumption in that national income accounting equation, that governments need to invest, we need an increase in big G. And Keynes had some interesting examples, didn’t he, about the Treasury, burying bottles full of bank notes, or paying people to dig up bottles. There were some really interesting examples in there. His whole idea was, the government just had to spend money to keep people to get people employed. The economy’s in a rut, it’s in a hole and it needs a big push to get it out of it. Is that a reasonable summary?

Tony Makin  06:18

That’s a very good summary, Gene. That’s exactly what he advocated. And a couple of points in response is that he assumed economies were close, there’s no exports or imports or exchange rates or capital flows, or foreign direct investment in his original theory, and that came under criticism from a subsequent British economist Hubert Henderson, who said that nothing in Henderson’s opinion had led economics more astray than Keynes’s hypothesis of reasoning that economies were closed or worse to that effect. They said this is totally at odds with the tradition of British economics. Adam Smith, David Ricardo, John Stuart Mill had all taken international factors into account when they looked at how economies behave. So that was one major admission in Keynes’s theory. And secondly, it’s not entirely correct that Keynesianism actually worked during the Great Depression. It said that governments didn’t spend enough but the secretary of the US Treasury at the end of the 1930s said that we’ve spent so much and it still doesn’t work. And then the second world war commenced soon after that, of course. But the jury’s still out on, you know, how effective that Keynesianism of the 1930s actually was. It was a very prolonged depression and the spending had been increased and some argue that because of the increased uncertainty that arose due to the big budget deficits and government interference in a major way in that period, it wasn’t just through fiscal policy, but with all sorts of interventions in the labour market and so on that created greater uncertainty which prevented private investment reviving, and hence prolong the Great Depression. In addition to that, and probably the major factor was that the US went highly protectionist, the tariffs that were imposed under the so called Smoot-Hawley bill in the 1930s was trying to close the US economy off to foreign competition. Tariffs went up enormously and global trade collapsed and that also contributed to the prolongation of the depression.

Gene Tunny  08:58

Yes, yes, very good point there about the tariffs. Tony, I’d like to ask you about the Australian response. I thought you made some really great observations about the different elements of the response. So, there was the Job Keeper programme, payroll subsidy programmes, cash handouts, and there’s also some bringing forward of infrastructure spending. You made some really insightful remarks regarding the efficacy and merits of the different elements of the Australian government response, and I think there are lessons that can apply to responses across the world. Would you be able to take us through what those those insights and lessons that you made were Tony?

Tony Makin  09:56

Yeah. Well, I made a distinction between fiscal responses that were targeting the aggregate supply side of the economy. And in the paper endorsed those in principle, and in particular, we’re talking about job keeper, which I think is a great innovation. We’ve not seen a scheme like that before. It’s not original to Australia, Australia copied what was happening in the UK and New Zealand and one or two other European economies. And the innovation was to see firms as a source of employment. Correct. And to alleviate the pressure on firms and their employees by providing a direct subsidy to the firm. So, it was a supply side initiative more than a demand side initiative. It was helping aggregate supply. It wasn’t an element that sought to increase C or I, it was increasing G, of course, but it was aimed at the firm’s production. So that was an innovation. And I think there’s a prototype there for future fiscal responses. Heaven, let’s hope we don’t have similar sort of crises. But it’s a preferred means as opposed to the aggregate demand side response – in the form of cash transfers or cash handouts – as we saw in response to the GFC trying to, in the Keynesian ways, stimulate spending. And the purpose of stimulating the spending is to enhance employment. So, it’s a roundabout way of trying to enhance employment. I think it has the features of a subsidy to retailers, in effect, because they’re the ones that benefit most. In any case, if there is spending and evidence shows that such handouts tend to be largely saved, but if they are spent, they are spent on imports and they’re funded by borrowing from overseas, which has to be paid in the future. So, there were two responses there that were trying to sustain employment one was the direct one to job keeper. Good marks for that one. And then there was another one on top of that, which was the cash handouts, which was a roundabout way of sustaining employment when there was another policy in place for that purpose.

Gene Tunny  12:43

Yep. So, this Job Keeper, it was originally costed at 130 billion. It turns out it may only cost 70 billion. There was a forecasting error. But that’s tangential to our discussion. You did note that while job keeper is more justifiable than other stimulus or emergency measures, there are still concerns with the design of Job Keeper. Could you take us through some of those please Tony?

Tony Makin  13:17

Look, the key one is the industries involved. The questions about casuals being paid more on job keeper than they were otherwise earning, so they are being paid more not to work than to work, I think is the key floor with the programme, and hopefully that will be fixed when the Treasury completes its review very soon. And I guess there’s also questions about eligibility and the rule was there for downturn in sales. Some of those aspects of it could be possibly fine-tuned, but I think it is a useful prototype that can be improved.

Gene Tunny  14:09

Yep. If they if they did it again, I’m sure they would better target it. And they might target it to the industries that are most affected such as hospitality, tourism, retail, possibly not professional services, which, you know, appear to be not as badly affected as some other sectors. So, the key lesson is that this needs to be better targeted. The problem was from what I can tell, this was developed within a week, possibly under a week, when toward the end of March realised that they needed something like this because all of the employer groups were coming to the government ministers and telling them we need this or we’re gonna have to sack millions of people. So, I think that’s what drove it. It was done very quickly.

Tony Makin  15:03

Yes. And, the alternative was to put enormous pressure on the employment benefit scheme. People queuing up for benefits would have been a major headache as well.

Gene Tunny  15:15

Absolutely. I think one of the great points you make in the paper was regarding the cash handouts: we want to get people out spending, but the public health advice is saying stay home, we don’t want you to go out. So, I thought that was a really interesting point. So, the goal of these emergency measures should be to sustain businesses to keep people in employment during this challenging time. The way to do that is not necessarily to give people money to go out and spend on new flat screen TVs which are imported. So, I think that’s a good point that you’ve made. What about infrastructure, Tony? What do you think about spending on infrastructure as a means to stimulate the economy and get people into employment?

Tony Makin  16:15

Infrastructure spending can be beneficial and it has lasting benefits, and what it does not do is deteriorate the government balance sheet, as does the spending on cash handouts and other forms of consumption related government stimulus. What infrastructure does is it creates an asset on the government’s balance sheet that matches the borrowing – it still has to be funded by borrowing. We started with a budget deficit, so all of this extra spending has to be funded by borrowing. And so, there’s an asset there to the balance sheet, which won’t deteriorate to the extent otherwise. But again, it needs to be quality spending, it needs to pass certain tests. The crude Keynesian idea would be again just to spend on anything. And digging holes in the ground, as you mentioned earlier, is a form of crude Keynesianism, which, could well be sort of portrayed as a form of infrastructure spending if it’s working on the road somewhere. But the point about infrastructure spending is it does have to pass the test where the present value of the benefits of the project exceed the costs. And one other point to make about infrastructure spending, and this is one feature of government spending that Keynes instanced in his work originally right back in the 1930s. He talked about public works, which is effectively what we call infrastructure today, but the difference between then and now when you talk about boosting infrastructure spending is that the nature of the workforce has changed dramatically. I mean, people these days have certain skills, it’s a highly variegated work workforce with people doing different things. And the assumption in Keynes’s theory was you increase spending on public works, then you have workers easily transferred from jobs that they’ve lost places of employment where they used to be in factories and other areas of unskilled work and they can easily be transferred to, you know, working on the road, so to speak, but these days that seems far-fetched because, for instance, baristas who’ve lost their jobs are not necessarily going to be out there on the road as a construction worker, financial sector employees and not wanting to be putting pink bats in ceilings. So, the nature of the workforce is important. We can’t just treat the labour force as this homogenous entity where people can transfer across to any sort of industry at whim. And there’s information costs, transactions costs, which which make the whole process a little bit trickier than it sounds in terms of increasing employment.

Gene Tunny  19:35

Yeah, it’s not like it was in the 30s when you could get a whole bunch of unskilled or semi-skilled workers, unemployed workers and have them carve out a walking track in the national park or something like that. So, there are a few examples of projects like that in Australia, where there were unemployed workers employed to do jobs just like that. I might put some links in the show notes. There is some fascinating examples. Okay, Tony, let’s get on to your criticisms of crude Keynesianism. So, you talked about the open economy perspective before. Also in your paper, you talk about the loanable funds view and Ricardian equivalence. So, these are all alternative perspectives. And you write, “These non-Keynesian perspectives backed by a body of empirical evidence tell us extra government spending aimed at bolstering the aggregate demand side has offsetting effects elsewhere in the economy that negate its purpose”. So that’s a very strong statement. I’m interested in the logic and evidence behind that statement. Please, Tony, would you be able to take us through that place?

Tony Makin  21:11

Sure, Gene, I set out the perspectives contrary to the crude Keynesian approach in my book, The Limits To Fiscal Policy, published just a few years ago, where I talk about the offsetting effects to increase government spending. The focus is mainly on increasing government spending as the form of fiscal injection – I hesitate to use the word stimulus because as the book argues, it’s not really in the end stimulus at all. But even before we talk about the open economy perspectives, we can hark back to criticisms that have been made. When you treat the economy as a closed economy, as we said earlier Keynes assumed, and criticisms from way back suggested that once you bring the flow of funds into the economy, then the pressure from government spending will increase interest rates because there’s an increased demand for funds. Governments have to borrow the funds to finance the extra spending. So that would push up interest rates put pressure on interest rates domestically, and that would crowd out domestic investment. So those funds would no longer be available for investment. And a couple of recent papers have talked about and quantified the extent of this when the banking sector is buying large quantities of newly issued government bonds that have been issued to fund the budget deficit, then that’s becoming an asset on their balance sheets instead of loans to the private sector to business for investment purposes. So, that’s one perspective, the sort of classic loanable funds perspective, which is grounded in a grounded in indisputable macro accounting. In fact, if you go to the identities, international accounts, you will come out with that model with the interest rate as the equilibrating variable between saving and investment.

Gene Tunny  23:51

Yeah, so the difference between the classical view and the Keynesian view is that it’s not just the interest rate that leads to the equality of saving and investment, but the adjustment of income. And that’s probably something to cover in an additional episode because we’re going to spend a half an hour or an hour chatting about that. But, yes. So, Paul Krugman, I’ll link to a paper by Krugman on the IS-LM model because IS-LM attempts to integrate that loanable funds view with the Keynesian view. And there’s a huge debate about to what extent it does that adequately. So, I might have to leave that for another discussion.

Tony Makin  24:38

I say I was just about to get on to IS-LM as the next step.

Gene Tunny  24:41

Okay, go ahead. Go ahead.

Tony Makin  24:44

Well, IS-LM was invented by Sir john Hicks, the Nobel Prize winner who, a contemporary of Keynes pointed out to him, in a paper published in the Economica, that Keynes had admitted to address the monetary side of the economy. And so, he introduced money demand and supply and presented the IS-LM framework for the first time. And that framework, again, a closed economy framework, was used by Milton Friedman to say, well, in the monetarist theory, the quantity theory of money explaining how money determines the inflation rate if it’s excessively produced – increased supply of money leads to higher inflation, the classic quantity theory – in that theory there’s no role for the interest rate as a determinant of money demand. And so, Friedman said, “Well, if that is the case, you’re gonna have a vertical LM curve”. And again, listeners might recall there IS-LM analysis and if you’ve got a vertical LM curve, even in a closed economy, if you increase big G, you’re still going to crowd out investment. Right? So, it’s consistent then with loanable funds, but they’re closed economy models. I prefer to stress more the open economy counter arguments to crude Keynesianism, and there’s several models there. So, I could go through those.

Gene Tunny  26:26

Yes, please. If you could take us through that basic mechanism. What happens and how does it offset the impacts of the stimulus?

Tony Makin  26:38

So in the open economy, where you introduce capital flows, exports imports, exchange rates, and emphasising in particular the exchange rate, then you can have a counter model to crude Keynesianism and the best known approach is the so called Mundell-Fleming model, which features in intermediate macroeconomics textbooks, and it really just builds upon the IS-LM model that Hicks invented by introducing capital flows and exchange rates and net exports. So, listeners may well be familiar with that model but it simply says that if you increase government spending, you’re going to increase the budget deficit, there’s going to be more spending in the economy, but for a given money supply is going to tend to push up domestic interest rates relative to foreign interest rates and that will induce capital inflow – foreigners will be flooding into buy these bonds that are paying a slightly higher interest rate than in their own countries – and that capital inflow will appreciate the currency. So, we’re talking about a floating exchange rate here. And that appreciation will worsen competitiveness because in the short run, price levels are fixed. So, a nominal appreciation will translate to a real appreciation. And that loss of competitiveness will crowd out net exports. And this is exactly what we saw post GFC. I’ve written on this. It’s part of the Treasury external paper. But the exchange rate appreciated massively. As the fiscal stimulus was being rolled out and just look at the national accounts, and you’ll see that the swing variable lay was net exports that went down due to the loss of competitiveness. That’s one open economy perspective and I think that model has been borne out empirically with reference to Australia’s previous experience post GFC.

Gene Tunny  29:06

Yes, I’ll put a link to that paper of yours which I think was in Agenda. And you also write a paper for the Minerals Council. One thing that’s really interesting, Tony, is that your original Minerals Council paper was criticised by the treasury secretary, Dr. Martin Parkinson, my old boss at the time. But then a couple of years later, you wrote a paper for the Treasury under the new secretary, John Fraser, essentially, almost refuting what Dr. Parkinson wrote in that rather extraordinary refutation of your Minerals Council paper.

Tony Makin  29:54

Yes. It’s quite curious and evidence that economists disagree – even Heads of Treasury disagree in economic thinking. So yes, Martin Parkinson issued a press release criticising my Minerals Council paper, which was mostly about Australia’s competitiveness. It was not focused on fiscal policy. That was a part of it. But that’s what copped the criticism from Treasury. And then subsequent to that, when John Fraser became Treasury head, he commissioned me to write a paper for Treasury, and that is available from the website, where I elaborated on the aspects in the Minerals Council paper about fiscal policy and raised some of these issues about counter models to crude Keynesianism.

Gene Tunny  30:53

Yeah. It’s interesting because, I mean, we both worked for Treasury at different times, though. I remember the traditional Treasury view is that you have to be careful about fiscal policy because it could end up being destabilising due to the open economy impacts that you’ve mentioned. There’s also the problem that you don’t know whether you’re intervene at the right time. The problem that, you know, the stimulus might come on when the economy is recovering anyway and then it’s, you know, it’s not really necessary. So, there are these lags involved. What happened, I think, during the GFC, or the global financial crisis, was that the Treasury people thought and the politicians Kevin Rudd, the Prime Minister, Wayne Swan, the treasure, they thought, we’ve get this huge shock coming from overseas, we’ve got to do something. So, we’re just going to throw as much money at the problem as we can to save the economy. That seems to be the logic and now all of those old concerns about discretionary fiscal policy what we call discretionary fiscal policy, as distinct from automatic stabilisers, such as unemployment benefits, which increase during recessions or the fact that your tax revenues fall during recessions that old view that discretionary fiscal policy is insensible; that was just thrown out the window. And we’re seeing it again now. So, do have any views on why the Treasury line on fiscal policy has changed, Tony?

Tony Makin  32:31

Well, I think it has become crude Keynesian. And there’s another example that you hadn’t mentioned, and it was the response to the Asian financial crisis, which was also a major, cataclysmic event at the time in terms of what happened to asset prices and we, by then, had been heavily dependent on the Asia Pacific for our trade. Not so with the GFC, because our trade with the North Atlantic region was minimal compared to Asia and yet the responses were completely different. In the first instance, there was virtually no fiscal response, there was a strong monetary response, which allowed the exchange rate to stay at a highly depreciated level, which saw us through that crisis. We didn’t experience a recession that time. And that was what was happening with the global financial crisis, the exchange rate collapsed, not as much as it did during the Asian financial crisis. But the government of the day then panicked, reflecting the panic in the US and by that time, interestingly, the International Monetary Fund had changed course in its thinking it has traditionally been influenced by Chicago economists and had always highlighted problems with activist fiscal policy, including the lags problem that you’ve mentioned, but there had been this major reversal of thinking at those levels and the Australian Government here panicked as a consequence of the crisis where it should not have given that the banking system here didn’t collapse in the same way as it did in the United States. I fully endorse the underwriting of the banking system at the time that, the fiscal stimulus was completely over the top in my view.

Gene Tunny  34:40

Yeah. And you mentioned the famous dictum from Bagehot that “central banks in a time of crisis should lend freely against good collateral”. So, providing that liquidity in the system, that’s the major way that central banks can assist in a crisis. And, you know, you’re comfortable with that, you’re comfortable with monetary policy measures. It’s the fiscal policy measures that you’re less comfortable with because of the fact that there are those offsetting impacts in that fiscal legacy. Tony, would you have time for one more question? I know we’ve run a bit over time. But one more question on that fiscal legacy.

Tony Makin  35:12


Gene Tunny 35:14

Okay. What do you see is the problem with this build-up of debt, and there’s the problem, we have to pay for it, or we have to service that debt and a lot of that money is going to go overseas. You’ve also mentioned the impact on economic growth. What evidence is there regarding the impact on economic performance and growth of a build-up of public debt, which in Australia is easily going to exceed $1 trillion within a few years.

Tony Makin  35:56

Well, there’s certainly got to be the impact on income because there’ll be a pure drain from national income of the public interest paid abroad, we’re talking about 10s of billions there that will just be subtracted from national income to service the debt that we will have and that drain will likely exceed about eight times the foreign aid budget and what spurred on the Pharmaceutical Benefits Scheme and a host of other government programmes. So, there’s going to be a direct impact there. But there have been a number of elaborate econometric studies done. And you find them in the literature, for instance, the IMF has done work on this. I’ve actually done a had a paper published with a PhD student of mine looking at Asian economies and there seems to be a consensus empirically that a 10% increase in public debt, out of the things you’re saying, will contract GDP growth, that’s conventionally defined GDP, by point two of a percent. So that might not sound much but you compound that through it can be quite significant over a few years.

Gene Tunny  37:20

What would be the mechanism there Tony? Would it be the fact that to service this debt, you might have to have taxes higher than otherwise? And these taxes lead to an efficiency loss. There’s an efficiency loss with taxation because you’re discouraging people from working or investing. Could that be one of the mechanisms?

Tony Makin  37:40

Yeah, absolutely. The interest rate is going to play a role as well. But the dead weight losses of the future taxes are going to harm future income. There’s no question about that. But also, other studies have shown that the interest rate will increase by a certain amount of basis points – 1% increase in the public debt to GDP ratio tends to in these studies show that the interest rate tends to go up by about five basis points or up to five basis points. But the mechanism through tax is important but also through expectations if you’ve got this big debt overhang, public debt overhang, that’s going to affect expectations and we can invoke Ricardo there in terms of what he said for households tending to save more but also firms, and it’s not something that Ricardo instanced, but I think it’s important that investment is likely to be weak due to the uncertainty that business has about future tax liabilities in the face of an enormous public debt. And then lastly, there’s the impact on future generations that Thomas Jefferson, a founding father of the United States instanced, that the future generations are going to have to pay for the repayment of the massive debt that’s arisen due to the fiscal response.

Gene Tunny  39:25

Yep. Okay, Tony, that’s been great. We didn’t even get to modern monetary theory or some of the other topics in your in your paper, but I’ll link to it for listeners to read: a highly recommended – a fiscal vaccine for COVID-19. Tony Makin, professor of economics at Griffith University, as Tony mentioned, he formerly worked for the International Monetary Fund. You’ve also worked for Australian government agencies. You’ve worked for the University of Queensland and you’ve taught at the Lee Kuan Yew School of Public Policy at the National University of Singapore. Tony, I really enjoyed that, are there any final points in wrapping up?

Tony Makin  40:09

Look, there’s a lot more we could talk about Gene, perhaps at another time modern monetary theory, I think, lends itself to a session.

Gene Tunny  40:17

Thanks so much, Tony. I appreciate it.

Tony Makin  40:22

Thank you. Bye bye.

Please send any questions, comments, or suggestions to or call us on 1300 169 870.

Free Economic Updates

Subscribe to receive our monthly economic e-newsletter, packed with the latest insights, hints and tips from our leading economists.
  • This field is for validation purposes and should be left unchanged.