The Irish economy appears to be bouncing back.
"If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions" – Winston Churchill
John Maynard Keynes is Britain's most famous economist. He is best known for his theory that whenever a country enters a recession, the state should actively manage the economy by increasing public spending to maintain the level of aggregate demand.
Keynes' theory has been adopted by most political parties in the developed world, and whenever you hear politicians discussing the level of public spending you'll find that it almost certainly lies at the heart of at least one side's argument.
One country that seems to have contradicted Keynes' theory, having reported strong economic growth for the last two quarters despite massive cuts in public spending, is Ireland. Or has it?
Is The Emerald Isle recovering?
After Ireland's banks imploded in 2008 its government dramatically slashed the level of public spending. Amongst other things it cut public sector workers' pay by at least 5%, something which is unheard of in most countries as this is usually done by giving pay rises which are below the rate of inflation (as is the case in Britain).
The cuts have continued apace and in the second quarter of 2011 the Irish economy defied the economists' predictions with growth of 1.6% compared to the first quarter (having grown by 1.3% in the first quarter), whilst the rest of the Eurozone grew by a mere 0.2%.
Keynes vs. Hayek
At face value these figures cast some doubt upon Keynes' theory. However, it turns out that growth was driven by exports (a 24% rise in net exports) whilst the level of domestic demand has shrunk by 2.2% during the past 12 months. So Keynes appears to be correct when it comes to the Irish economy, with public spending cuts causing domestic demand to decline.
But the figures for the lightly regulated export sector demonstrate that Keynes' main opponents, Frederick Hayek and the Austrian School of Economics, are also correct. Hayek and the Austrians argue that freeing up markets is the best way to produce economic growth and this is what has happened.
Clearly when Mark Twain said that there were "lies, damned lies and statistics" he had economics in mind! Still, quarterly growth of 1.6% is not to be sneezed at and unlike Greece, which is still in deep denial over its economic problems, Ireland was and is prepared to face up to the facts.
Economics is a far simpler subject than the economy itself, which is often a capricious and highly unpredictable beast. The debate between Keynes and Hayek will run and run.
Good news, the bond market liked it
The market liked the figures and the yields on long-dated Irish government bonds have fallen sharply since they were announced. Yesterday the rate paid on 10-year bonds dropped to below 8%, having reached 14% in July, although this is still more than three times what Britain has to pay.
I'll finish by pointing out that whilst Keynes' theory comes in two parts, most politicians who call themselves Keynesians only seem to know the bit about increasing public spending during a recession. The second part of Keynes' theory holds that the government must run a budget surplus during an economic boom, in order to build up the reserves which it can then spend during the next recession.
In nearly every country where politicians are now calling for Keynesian stimulus packages, the government did no such thing (because it would cost them votes).
More on the markets:
> Tony is an Austrian.
