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THE government debt of the ten richest countries attending the G20 summits will hit 114% of GDP by 2014, up from 78% in 2007, according to a new IMF study. To measure how much fiscal pain would be required to bring gross debt ratios to a sustainable level, the IMF looked at demographic pressures and assumed that long-term interest rates exceed economic growth rates by a percentage point (the long-term pre-crisis average) and then calculated by how much primary budget balances would have to improve. The economists define this level as 60% or, for Japan, half of today’s figure (ie, 85%). Their results suggest that Ireland and Japan have most to do. Both would need to boost their primary balances by more than 12% of GDP, compared with what is forecast for 2014. Britain would need an improvement of close to 6%. The gap in America is 3.5% and in Germany just under 2%.

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That economics is not a natural science is clear from the inconclusive engagements that have punctuated its own history. A hundred years ago the classical theory reigned supreme. This “proved” that free markets were automatically self-adjusting to full employment. They were either continually at full employment or, if disturbed by an outside shock, rapidly returned to it. The only thing capable of wrecking the workings of the market’s invisible hand was the visible hand of government interference.

Then along came the Great Depression of 1929-32 and John Maynard Keynes. Keynes “proved” that markets had no automatic tendency to full employment. This failing of the invisible hand justified government policies to maintain full employment.

For 30 years or so Keynesianism ruled the roost of economics

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Keynes answered to critics of the General Theory, in 1937, that they failed to realize that there were two main innovations in that work. The first, was the relationship between money demand and uncertainty; the second was the consumption multiplier. The relation between money demand and uncertainty was in fact the main reason to explain why aggregate demand could fall short of full employment income. However, this was explained by Keynes in 1937 by recourse to a form of precautionary demand for money. In The GT, Keynes had actually merged the precautionary demand into the transactions demand for money, making it very difficult for any reader, friendly or unfriendly, to actually see what he meant in 1937. As a result, Keynes liquidity preference theory of the interest rate in the GT exhibited some important shortcomings that were the subject of many reexaminations, including one by Richard Kahn and another by James Tobin. The paper evaluates Keynes's views, Kahn's and Tobin's solutions to Keynes's dilemmas. At its conclusion it is shown why these themes remain relevant today, particularly when financial systems are in turmoil.

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Governments cling to the delusion that a crisis of excess debt can be solved by creating more debt.

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In an excellent article, Bradford Delong, the renowned Professor of Economics of the University of California at Berkeley, had brought out the differences – straight and subtle – between the theories and view points of the Economists John Maynard Kenes and Milton Friedman; both of whom are considered the greatest of the economic thinkers of the previous century.

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I shall always remember Keynes with his pipe and files marked 'secret' but it is Friedman whose week-long association in a Sussex village that I value more.

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Keynes, who died in 1946, said market forces don't necessarily come into equilibrium on their own. In such circumstances, governments should increase spending to boost demand and help return the economy to full employment.

That idea spread around the world in subsequent decades, said Smith, "and it came to be widely believed that one of the roles of government was to prevent business cycles and stabilize the economy as a whole, and that the government could do that in part by following what's sometimes called a counter-cyclical fiscal policy where they would spend more in recessions and less in booms."

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