From Keynes to COVID-19 and beyond


In the wake of the signing of the Treaty of Versailles in 1919, a book was published that made its author, the economist John Maynard Keynes, famous. Largely forgotten today, “The Economic Consequences of the Peace” predicted that Germany would collapse under the burden of paying war reparations. 100 years later, should we worry about the “collapse” of the young generation under the burden of paying for COVID-19?


The words of Keynes are still valid

In 2007, a reprint of Keynes’s book appeared with an introduction by Paul Volcker, a former Chairman of the Federal Reserve, who wrote: “…- I am struck not just by the felicity of Keynes’s prose and the passion of his concerns but by the relevance to the world in which we live.”

Given the COVID-19 lockdowns and their impact on the economy, Volcker’s observation remains valid today and, with future generations in mind, we have to consider whether or not we are pursuing the appropriate economic and monetary policies.

Are we so focused on the elderly in Europe that we are ignoring the future of younger members of society? What about the “COVID-19 generation”, those under 25, who may be studying at school or in further education, or are perhaps working in poorly paid and relatively insecure jobs?

In the following paraphrased quote from The Economic Consequences of the Peace, the word “Germany” has been replaced with “the COVID-19 generation” (and the word “nation” should also be understood as such):

I cannot leave this subject as though it’s just treatment wholly depended either on our own pledges or economic facts. The policy of reducing the COVID-19 generation to servitude for a generation, of degrading the lives of millions of human beings, and of depriving a whole nation of happiness should be abhorrent and detestable, - abhorrent and detestable, even if it were possible, even if it enriched ourselves, even if it did not sow the decay of the whole civilized life of Europe.

We are talking here about economic and monetary policies that have persisted over decades but prove ineffective when they are needed most.

As an example, while in office, Federal Reserve Chairman Alan Greenspan introduced what came to be known as “the Greenspan put” – a pledge to support the equity market every time it was hit by adversity. Eventually, this policy was a contributory factor to the financial crises of 2008-2009, since when central banks, especially the ECB, have supported the financial markets by lowering interest rates (even taking official rates into negative territory in the process), providing cheap liquidity and launching a number of securities purchase programs.

The latest such program is essentially big enough to acquire all the government debt that has been issued as a consequence of the pandemic’s perceived economic impact.

In today’s world of COVID-19 and vaccinations, it feels very much as if the financial markets need a new “liquidity jab” every time something adverse happens.

William White, former Deputy Governor of the Bank of Canada, in a recent interview[1] with Danielle DiMartino Booth, rightly states that the more one uses a monetary instrument the less effective it becomes.

The fundamental question must be: Are we close to a situation in which monetary policy is no longer effective?

Effectiveness of monetary policies

In a very simple economic model, interest is the compensation received for postponing consumption until the next period.

Since the financial crises, the ECB has lowered interest rates and provided more liquidity than ever. At the end of 2020, the yield curve in German government bonds had negative interest rates up to 30 years. Under such conditions, there should therefore be little incentive for consumers to postpone consumption since their money will be worth less tomorrow. Have consumers reacted to these negative interest rates?

Also simplified, the current account of an economy is the sum of the current account of its private sector plus the current account of its public sector (deficit or surplus of the General Government).

The chart below shows the development in Germany of the current account and its two components:

Figure 1 Germany’s current account broken down between private and public sector source Eurostat

It is clear from the chart that, in times of crisis (e.g. 2009), the private sector consumes and invests less, while the public sector increases spending. However, since March 2016, official ECB rates have been below zero. This has reduced the current account surplus slightly in the private sector, but why has this reduction not been greater?

At the end of 2020, the yield on 30-year German government bonds was -0.17%, so how much would such an investment return in real-value terms over the life-time of such a bond? The following chart illustrates this:

Figure 2 Development in real value of investment in 30-year German government bond

Without any inflation, real value only falls to 95% of the invested amount in 30 years’ time. With inflation, however, the result is quite different. Applying the average inflation level of the last 30 years, real value is diminished to just over 50% after 30 years, while 4% inflation reduces real value by around three-quarters. Such uncertainty only leads to increased savings.

Keynes on COVID-19

The current monetary and fiscal policies being pursued are focused entirely on avoiding any economic consequences for large parts of the population. We are right now tackling the economic impact of COVID-19 by issuing huge amounts of debts that will most likely have little real value when they are repaid.

To again paraphrase Keynes, one section of the European population is being deprived of its future in order for the rest to continue as if nothing has happened. This has gone wrong before and it might go wrong again.

It might be time to reconsider our economic and monetary policies for the sake of future generations.

Be safe.



About the Author

Gustav Jensen

Gustav is the managing director of Quantrom Limited and is living in near Brussels.

Economist from University of Copenhagen mainly working in finance and banking.