Intellectuals and politicians often try to summarise or justify conventional thinking in pithy ways.

Milton Friedman (in 1965) and Richard Nixon (in 1971) both used different versions of the phrase: “We are all Keynesians now.”

John Maynard Keynes, one of the most famous economists of all time, supported deficit spending and government manipulation of economic activity, and Friedman and Nixon were both referring to the Great Society redistribution programs and the inflationary monetary policy designed to offset their cost.

If economic policy was Keynesian in the 1960s and 1970s, as policymakers moved away from free market ideology, we are certainly all Keynesians now.

COVID-19 spending and monetary policy are a clear continuation of this economic thinking.

It all began in 2008 when the Bush and Obama administrations spent $1.5 trillion in taxpayer money to “rescue” the US economy, and the Federal Reserve (Fed) began quantitative easing (QE).

That blueprint of policy response to the Panic of 2008 was used to respond to COVID-19 shutdowns.

This time, the US Federal Government borrowed at least $5 trillion to spend, and the Fed increased its balance sheet by over $4.5 trillion.

As a result of the Keynesian policies of the 1970s, the US experienced stagflation (slow growth and high inflation) – with both unemployment and inflation peaking in the double digits.

Currently, inflation in the US is 8.1 percent, and the unemployment rate is 3.6 percent. So, while inflation is clearly happening, signs of stagflation are harder to find.

This doesn’t mean economic growth isn’t being impacted. Multiple factors need to be analysed and untangled to fully understand the ramifications of lockdowns and government largesse.

First, the US economy was artificially boosted by borrowing money and distributing it through government loans and pandemic benefits.

Second, the US M2 money supply (measure of the money supply that includes cash, checking deposits, and easily-convertible near money) has increased more than 40 percent since February 2020, as the Fed renewed QE and monetised deficit spending.

In other words, a great deal of that spending was paid for out of thin air.

The impact of these policies was like giving morphine to an accident victim. The lockdowns dramatically damaged the economy, but the morphine masked the pain. All that pain-killer stimulus boosted sales and profits.

This year, without new spending legislation—and, asؙ the Fed starts to reverse course, the economy will lose its morphine drip.

On the surface, this suggests that the economy could be in trouble, but this ignores the impact of the third factor at play—its reopening.

At least to me, it is clear that generous pandemic unemployment benefits had a massive impact on employment. In fact, the “Great Resignation” has had a lot to do with these benefits.

While it was never the case, many thought the Build Back Better (BBB) spending bill would keep the money coming. Now that BBB appears dead, those people are heading back to work.

In the first three months of 2022, 1.69 million jobs in the US have been filled, and this year will likely total four million jobs or more.

So, even though the Fed will be lifting rates and Keynesian deficits will fall, the economy will expand in 2022, and profits should continue to rise.

Unfortunately, we forecast that real GDP growth in the US will remain at less than three percent while inflation remains above five percent. This is reminiscent of the 1970s and, once society reopens fully following COVID-19 lockdowns, the full impact of these policies will be felt.

The recent inversion in the yield curve suggests the bond market thinks that, if the Fed lifts short-term rates to three percent or so, it will be forced to cut rates again.

This may be true, but we think inflation will prove a more persistent problem than the Fed or the bond market has priced in.

The US is now stuck in a Keynesian dilemma of its own making, and the way out is to cut spending, cut tax rates, cut regulation, and tighten money enough to stop inflation. Because in the end, Keynesian policies don’t create wealth; free and open markets do.

Brian S. Wesbury is Chief Economist at First Trust Global Portfolios. 

This article represents the views of the author.

This article was first published on FM Report.