Keynesian Economics vs. Classical Economics and Austerity
Pictures from left to right: Socrates, Karl Marx, David Ricardo, Franklin Roosevelt, John Maynard Keynes, George Bush, President Obama, and Janis Yellen
Introduction: This was an article I wrote a few years ago when a big debate was being waged concerning Keynesian Economics, Classical Economics and Austerity.
One reason why I chose to re-post it because Donald Trump is attempting to shift the country away from the economic theory which Obama based his economic policies on. Therefore, some of the same economic arguments waged during the economic recession in 2008, are still relevant today.
This essay is a bit long, so it might not appeal to those friends who have no interest in economics. Therefore, I will not be offended if you don't bother to read it. I am sure there are some who might disagree with my analysis, so feel free to express your disagreements.
Forward: The ideas contained in this essay were based on a book I read called “Aftershock, The Nest Economy & American's Future by Robert B. Reich”. After reading the book I was inspired to write this essay and post it on the blog. My understanding of economics is based on some minor readings of “Das Capital” by Karl Marx and from a general economic class I took in college. I hope this essay may inspire others to start critically examining what we are being told by conservative economist who claims that only “austerity” will solve the general economic crisis.
There have been a lot of debates among political elites concerning Keynesian Economics, Classical Economics and Austerity. I have posted several articles from Wikipedia to give you the reader a clear definition of the three theories before I began my discussion concerning my views. Based on my limited understanding of basic college economics 101-102, I had to refresh my understanding of these theories before beginning my academic discussion. If you disagree or agree, please post comments on why you disagree or agree.
Let's start the discussion with the Greek Philosophy Socrates. Socrates believes that a wide range of discussions on a type of pedagogy in which a series of questions are asked would not only draw individual answers, but “encourage insight into the question at hand. In other words, we can increase our understanding and arrive at truth through debate, let the debate begin.
According to John Maynard Keynes, when private businesses make bad decisions that lead to “inefficient macroeconomic outcomes”, the state must then play a fundamental role to bring the economy out of crisis. Even though some might disagree with many of Karl Marx's economic theories, he accurately predicted that capitalist economies would go into crisis every 10 to 20 years. He based his theory on the idea that as more wealth is concentrated in the hand of a few people, workers would no longer be able to buy the goods they produce. Karl Marx's theory was seriously examined by many leading economist during the great depression around 1930. After the great depression, the government set-up the central bank and passed many anti-trust laws to prevent a major crisis. I would argue that some of Marx's tenets need to be re-examined because the US has never had a major crisis since 1930. I think that one might surmise that the reason why we have not had a crisis since 1930 had something to do with the development of a central bank. But since that is not the central theme of this essay, I will put that discussion aside for a later period.
Keynesian economics Keynesian economics is based on a mixed economic approach that involves private, public and government involvement to keep the economic from going into crisis. Since the financial crisis in 2008, demand-siders are starting to re-examine his theory. In my opinion President Obama and George Bush may not be Keynesian's, but both stimulus policies were based on Keynesian economics.
President Roosevelt was one of the first presidents to implement Keynesian policies during Great Depression in 1930. His program was called the New Deal. According to Wikipedia, “in his first hundred days in office, which began March 4, 1933, Roosevelt spearheaded major legislation and issued a profusion of executive orders that instituted the New Deal—a variety of programs designed to produce relief (government jobs for the unemployed), recovery (economic growth), and reform (through regulation of Wall Street, banks and transportation). The economy improved rapidly from 1933 to 1937, but then relapsed into a deep recession.”
Franklin Delano Roosevelt January 30, 1882 – April 12, 1945), also known by his initials, FDR, was the 32nd President of the United States (1933–1945)
During the Great Depression, Roosevelt did increase government spending to order to put people back to work. He radically re-organized the government under the New Deal and designed a variety of social government programs (mentioned above) which gave the federal government more control over the economy. Many supply-side economist in the Republican Party and those preaching free trade blamed Roosevelt for increasing the size of government. While it can be argue that Roosevelt did increase government programs, these programs have kept the economy from going into a depression over the last 60 years. One can develop a convincing argument based on economic history that Keynesian economic policies have kept the economy out of crisis.
George Bush and President Obama George Bush implemented Keynesian policies by pumping billions of dollars into major banks during the Economic Recession in 2008. When President Obama came into office, he continued the same policies but he demanded more accountability. Although one can develop a pervasive political argue for Obama decision, but looking at it from a pure economic argument standpoint, he made a series of bad decisions concerning the crisis in my opinion. When he came to the White House he allowed his economic advisers who were linked to Wall Street to continue giving bail out money to large banks. Once these large banks got the bail-outs, they used the money to buy out their competitors rather than loan the money to small firms that was hurt by the crisis. They raided the government treasury while small firms continue to go out of business and unemployment continued to climb. President Obama should have nationalized or put these large firms into receivership, this would have loosened up the credit markets and allowed small firms to keep their doors open. President Obama's stimulus program was not a complete failure because he demanded more accountability for paying back government loans. Firstly, the banks and financial institutions had to pay back the money with interest and secondly, they had to give the federal government shares in their institutions until the loans were re-paid. In summary, President Obama can strongly argue that his economic approach worked better than President Bush’s approach because he added around 8 millions jobs to the economy. The auto industry that was on the brink of collapsing is now hiring new workers and unemployment is now around 6.0%. If the economy continues to grow, (even at a slow pace) it might be around 5.0% by next year according to some economist. The government considers 4.0% as full employment under our system.
Classical Economics
Conservative economist argues that the reason why the economy went into recession in 2008 was because the government was spending too much money and imposing too many regulations on private business. They want less government spending, tax cuts and getting rid of government regulations which they claim hurt businesses. This approach is based what is called austerity and can also be referred to as the classical economic approach.
David Ricardo (18 April 1772 – 11 September 1823) was the first Englishman to advance the classical economic approach. Keynesian's were opposed to this approach. This approach was based on what became known as Say's Law. I will discuss more about the law later. The classical economist called for little or no government intervention in the economy. They believe that the law of supply and demand would eventually correct any economic ma-adjustments. They along with many conservative Republicans further surmised that after the 1930 crash, as stated above, there were no need for government involvement because the economy would have eventually recovered on it's own once the supply (overproduction of goods decreased), the demand for goods would put people back to work.
The neoclassical theory holds that two main cost influence supply and demand: labor and money. If there is too much labor, the price of labor will fall. If there is too much savings and not enough spending, then interest rates will fall. This approach might work if we are willing to let the economy go into a depression and wait until demand for goods and services put workers back to work. The truth is folks, no economist or government official is willing to risk such a drastic approach because it might bring about a revolution or mass social upheaval.
Supply and Demand "Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.
The two basic laws of supply and demand are:
• If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity.
• If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.
Wikipedia
Say’ Law
As discussed above, the central tenet of the classical view, known as Say's law, states that "supply creates its own demand, so Say's Law can be interpreted in two ways. First, the claim that the total value of output is equal to the sum of income earned in production is a result of a national income accounting identity, and is therefore indisputable. A second and stronger claim, however, that the "costs of output are always covered in the aggregate by the sale-proceeds resulting from demand" depends on how consumption and saving are linked to production and investment. In particular, Keynes argued against Say's Law by pointing out Say's Law only holds if increases in individual savings exactly match an increase in aggregate investment." Wikipedia
Demanding products requires the possession of money which is based on supply. Assets and or labor are used to produce money which creates demand. A person holding on to their money distorts the law because aggregate supply will not equal aggregate demand. When workers are unemployed, they hold on to their money and producers will not spend money if they cannot get a proper return. Since we do not spend all of the money that we have in our possession, the demand for current goods and services will not equal the value of what has been produced. If producers cannot get the price they demand, they will hold on to their money which in turn would create recession and economic crisis.
Keynes sought to develop a theory that would explain determinants of saving, consumption, investment and production. In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy.
Neoclassical economist argues that the two main costs that shift demand and supply are labor and money and distribution of the monetary policy. They argue these two things can be adjusted through demand and supply; if there were “more labor than demand for it, wages would fall until hiring began again. If there were too much saving, and not enough consumption, then interest rates would fall until people either cut their savings rate or started borrowing”.
Macroeconomist who are associated with the Keynesian school “advocate that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, particularly monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. The theories forming the basis of Keynesian economics were first presented in The General Theory of Employment, Interest and Money, published in 1936. The interpretations of Keynes are contentious and several schools of thought claim his legacy. As discussed above, Keynesian economics advocates a mixed economy which evolves private and public sections (which was mention above) playing and equal role in government, but the public sector plays the significant role. According to Wikipedia, this economic model has played a dominate role since the:
“later part of the Great Depression, World War II, and the post-war economic expansion (1945–1973), though it lost some influence following the tax surcharge in 1968 and the stagflation of the 1970s. The advent of the global financial crisis in 2008 has caused resurgence in Keynesian thought”.
Theory
According to Keynesian theory, some individually-rational microeconomic-level actions — if taken collectively by a large proportion of individuals and firms — can lead to inefficient aggregate macroeconomic outcomes, wherein the economy operates below its potential output and growth rate. Such a situation had previously been referred to by classical economists as a general glut. There was disagreement among classical economists on whether a general glut was possible. Keynes contended that a general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn. Losses of potential output due to unnecessarily high unemployment are the result. Producers then react defensively (or reactive) making decisions that damage macroeconomics.
Most Keynesian's advocate an active stabilization policy to reduce the amplitude of the business cycle, which they rank among the most serious of economic problems. Government policies can be used to increase aggregate demand, thus increasing economic activity, reducing unemployment and deflation. For example, when the unemployment rate is very high, a government can use a dose of expansionary monetary policy.
Keynesian’s argued that the solution to the Great Depression was to stimulate the economy ("inducement to invest") through some combination of two approaches: 1: A reduction in interest rates, and 2: government investment in infrastructure. Investment by government injects income, which results in more spending in the general economy. This in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment. Janet Yellen, the New Federal Reserve chairman has stated that she plans on keeping interest rates low for the foreseeable future because unemployment is still high and the housing market is still weak.
A central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards full employment levels. This conclusion conflicts with economic approaches that assume a strong general tendency towards equilibrium. In the 'neoclassical synthesis', which combines Keynesian macro concepts with a micro foundation, the conditions of general equilibrium allow for price adjustment to eventually achieve this goal. More broadly, Keynes saw his theory as a general theory, in which utilization of resources could be high or low, whereas previous economics focused on the particular case of full utilization.
The new classical macroeconomics movement, which began in the late 1960s and early 1970s, criticized Keynesian theories, while New Keynesian economics has sought to base Keynes' ideas on more rigorous theoretical foundations.
Some interpretations of Keynes have emphasized his stress on the international coordination of Keynesian policies, the need for international economic institutions, and the ways in which economic forces could lead to war or could promote peace.
Keynes sought to develop a theory that would explain determinants of saving, consumption, investment and production. In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy.
Because of what he considered the failure of the “Classical Theory” in the 1930s, Keynes firmly objects to its main theory—adjustments in prices would automatically make demand tend to the full employment level.
Neo-classical theory supports that the two main costs that shift demand and supply are labor and money. Through the distribution of the monetary policy, demand and supply can be adjusted. If there were more labor than demand for it, wages would fall until hiring began again. If there were too much saving, and not enough consumption, then interest rates would fall until people either cut their savings rate or started borrowing.
Conclusion:
If Roosevelt had relied on this approach, he would have put our democracy in danger. Many conservative economists argued today that the economic would have eventually recovered with out the massive government spending and reforms, but at what cost. Karl Marx based his theory of revolution on his understanding of classical economics. What he could not have predicted (because of his time in history), is the role governments played during economic crisis. After 1930 depression, capitalist governments as stated above had developed many federal policies which were designed to delay major economic crisis. One can argue that some of these policies put capitalism on trial because they moved their governments away from the idea of pure capitalism and more toward a mixed economic.
Understanding Say's Law of Markets
Beware measures to boost aggregate demand.
JANUARY 01, 1997 by STEVEN HORWITZ
One of the problems in the world of ideas, particularly in the social sciences, is that the insight behind old ideas can get lost as new ideas crowd the intellectual landscape. Often, the historian of ideas has the thankless task of reminding his colleagues that what they think some long-dead writer said is not, in fact, what he was talking about at all.
Such misunderstandings are frequently more than just simple errors; they can have profound effects on our theories of the social world, our interpretations of history, and our proposals for policy. In economics, one can find numerous examples of this phenomenon. My task here is to explore one of them: the way in which Say’s Law of Markets (named for the great Classical economist Jean-Baptiste Say) has been fundamentally misunderstood by economic theorists and laypersons alike, and to explore some of the consequences of this misunderstanding.
W. H. Hutt once referred to Say’s Law as the most fundamental ‘economic law’ in all economic theory. In its crude and colloquial form, Say’s Law is frequently understood as supply creates its own demand, as if the simple act of supplying some good or service on the market was sufficient to call forth demand for that product. It is certainly true that producers can undertake expenses, such as advertising, to persuade people to purchase a good they have already chosen to supply, but that is not the same thing as saying that an act of supply necessarily creates demand for the good in question. This understanding of the law is obviously nonsensical as numerous business and product failures can attest to. If Say’s Law were true in this colloquial sense, then we could all get very rich just by producing whatever we wanted.
In a somewhat more sophisticated understanding, one which John Maynard Keynes appeared to pin on the Classical economists, Say’s Law is supposed to be saying that the aggregate supply of goods and services and the aggregate demand for goods and services will always be equal. In addition, Say was supposed to have been saying that this equality would occur at a point where all resources are fully employed. Thus, on this view, the Classical economists supposedly believed that markets always reached this full-employment equilibrium. In one sense this is trivially true. If we compare the actual (ex post) quantities of goods bought (demanded) and sold (supplied) they will always be equal. Whatever is sold by one person is bought by another. Presumably, however, Keynes thought the Classical economists meant something else, perhaps more along the lines of market economies will never create general gluts or shortages because the income generated by sales will always be sufficient to purchase the quantity of goods available to buy. There is a strong sense in which this is true, but by itself it does not assure that full employment will take place because obvious examples of significant unemployment and unsold goods can easily be pointed to. And, in fact, this is what critics of Say’s Law have done. By pointing to the various recessions and depressions that market economies have experienced, they claim to show that Say’s Law was at the very least naive, and probably downright wrong.
What Say Said
If we want to get a more accurate understanding of Say’s Law, perhaps we should consult what Say himself had to say about his supposed law. In the passage where he gets at the insight behind the notion that supply creates its own demand, Say writes: “it is production which opens a demand for products. . . . Thus the mere circumstance of the creation of one product immediately opens a vent for other products.” Put another way, Say was making the claim that production is the source of demand. One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production. Wealth is created by production not by consumption. My ability to demand food, clothing, and shelter derives from the productivity of my labor or my non-labor assets. The higher (lower) that productivity, the higher (lower) is my power to demand.
In his excellent book on Say’s Law, Hutt states this as: “All power to demand is derived from production and supply. . . . The process of supplying—i.e., the production and appropriate pricing of services or assets for replacement or growth—keeps the flow of demands flowing steadily or expanding.” Later, Hutt was to be somewhat more precise with his definition: “the demand for any commodity is a function of the supply of noncompeting commodities.” The addition of the modifier noncompeting is important. If I sell my services as a computer technician, it is presumed that my resulting demands will be for goods and for services other than those of a computer technician (or something similar). The goods or services competing with those that I sell can always be obtained by applying my labor directly, so I am unlikely to demand them. The demand for my services as a computer technician is a result of the supplying activities of everyone but computer technicians.
This way of viewing Say’s Law gets at the interconnections between the various sectors of a market economy. In particular, it makes sense of the claim that the employment of all is the employment of each. As each worker finds employment, he or she is able to turn around and demand goods and services from all other noncompeting suppliers, creating the opportunity for their employment. From this perspective, Say’s Law has nothing to do with an equilibrium between aggregate supply and aggregate demand, but rather it describes the process by which supplies in general are turned into demands in general. It is always the level of production which determines the ability to demand.
Production Must Come First
This process can be seen in the differences between small, poor, rural towns and wealthier suburban areas. In the small town, the fact that less value is being produced by residents means that their ability to demand goods and services is correspondingly limited. As a result, the selection of products, the number and diversity of sellers, and the degree of specialization among producers is quite limited. By contrast, in the wealthier suburb, there is an amazing array of products, with a large number of diverse sellers all offering very specialized goods. Perhaps most important is that in the wealthier area, there is a greater degree of competition, as the market can support multiple sellers of particular goods given the level of wealth being generated by producers. Say points out that this explains why a seller will likely get more business as one among a large number of competitors in a big city than the sole seller of an item in the more sparsely populated countryside. The key to understanding Say’s Law of Markets is that it is production that must come first. Demand, or consumption, follows from the production of wealth.
To a degree, Say’s Law is just an extension of Adam Smith’s insight that the division of labor is limited by the extent of the market. Smith’s point was that the degree of specialization that one would see in a given market depended upon how much demand there was for the specialized product. Thus, small towns rarely have ethnic restaurants beyond the very popular Chinese and Italian, nor do they have radio stations that specialize in very narrow musical formats (oldies from the 1970s only, for example). Larger, wealthier communities can support this degree of specialization because there is sufficient demand, deriving from a larger population and a larger degree of wealth being produced. It is in this sense that production (supply) is the source of demand.
Because all movements between supplying and demanding have to take place through the medium of money, it is somewhat oversimplified to say that production is the source of demand. Actually demanding products requires the possession of money, which in turn requires a previous act of supply. We sell assets or labor services for money, which we then use to demand. Money is an intermediate good that enables us to buy the things we ultimately desire. However, we have to be careful to remember that what enables us to purchase is not the possession of money, per Se, but the possession of productive assets that can fetch a money’s worth on the market. When we sell that asset (or our labor services) we receive wealth in the form of money. As we spend that money, we demand from the wealth our production created. However, because we do not spend all of our wealth that we temporarily store as money, but choose to continue to hold some of it in the monetary form, the demand for current goods and services will not precisely match the value of what has been produced, as some money remains in the producers’ possession. Thus it looks as though, given the existence and use of money, Say’s Law, even rightly understood, leaves open the possibility that aggregate demand is insufficient to purchase what has been supplied.
However, if the monetary wealth is stored in the form of bank-created money, such as a checking account (but not Federal Reserve Notes), then that withheld consumption power will be transferred to those who borrow money from the bank that created it. The money I leave sitting in my checking account is the basis for my bank’s ability to lend to others. The power to consume that I choose not to utilize by leaving my production-generated wealth as money is transferred to the borrower. When she spends her loan, her addition to aggregate demand fills in for the missing consumption demand resulting from my decision to hold money. There is, therefore, no excess or deficiency in aggregate demand, as long as the banking system is free to perform this process of turning the saving of depositors into the spending of borrowers. Say’s Law of Markets cannot be fully appreciated unless one understands the working of the banking system and its role in intertemporal coordination.
(Intertemporal is the process by which people make decisions about what and how much to do at various points in time, when choices at one time influence the possibilities available at other points in time)
All Markets Are Money Markets
Because all market exchanges are of goods or services for money, all markets are money markets, and the only way there can be an excess supply or demand for goods is if there is an opposite excess supply or demand for money. Take the more obvious case of a glut of goods, such as one might find in a recession. Say’s Law, properly understood, suggests that the explanation for an excess supply of goods is an excess demand for money. Goods are going unsold because buyers cannot get their hands on the money they need to buy them despite being potentially productive suppliers of labor. Conversely, a general shortage, or excess demand for goods, can only arise if there is an excess supply of the thing goods trade against, which can only be money. Recessions and inflation's are, therefore, fundamentally monetary phenomena, as Say’s Law points us in the direction of looking at what is going on in the production of money to explain the breakdown of the translation process of production into demand.
Unlike Keynesian critics of Say’s Law of Markets who saw deficient aggregate demand resulting from various forms of market failure as causing economic downturns, we have argued that a more accurate understanding of Say’s Law suggests that there is no inherent flaw in the market that leads to deficient aggregate demand, nor is the existence of real-world recessions a refutation of the Law. Rather, once we understand the role of money in making possible the translation of our productive powers of supply into the ability to demand from other producers, we can see that the root of macroeconomic disorder is most likely monetary, as too much or too little money will undermine that translation process. Despite having been dismissed in the onslaught of the Keynesian revolution, Say’s Law, when properly understood both in its original meaning and its relationship to the banking system, remains a powerful insight into the operations of a market economy.
Sources:
STEVEN HORWITZ
Understanding Say's Law of Markets
Beware measures to boost aggregate demand.
JANUARY 01, 1997
http://www.fee.org/
…/det…/understanding-says-law-of-markets/ Wikipedia: Say's Law
http://en.wikipedia.org/wiki/Say%27s_law
Robert B. Reich
"Aftershock", The Nest Economy & American's Future
Karl Marx
Das Capital
Say's Law Of Markets
http://www.investopedia.com/terms/s/says-law.asp
Pictures from left to right: Socrates, Karl Marx, David Ricardo, Franklin Roosevelt, John Maynard Keynes, George Bush, President Obama, and Janis Yellen
Introduction: This was an article I wrote a few years ago when a big debate was being waged concerning Keynesian Economics, Classical Economics and Austerity.
One reason why I chose to re-post it because Donald Trump is attempting to shift the country away from the economic theory which Obama based his economic policies on. Therefore, some of the same economic arguments waged during the economic recession in 2008, are still relevant today.
This essay is a bit long, so it might not appeal to those friends who have no interest in economics. Therefore, I will not be offended if you don't bother to read it. I am sure there are some who might disagree with my analysis, so feel free to express your disagreements.
Forward: The ideas contained in this essay were based on a book I read called “Aftershock, The Nest Economy & American's Future by Robert B. Reich”. After reading the book I was inspired to write this essay and post it on the blog. My understanding of economics is based on some minor readings of “Das Capital” by Karl Marx and from a general economic class I took in college. I hope this essay may inspire others to start critically examining what we are being told by conservative economist who claims that only “austerity” will solve the general economic crisis.
There have been a lot of debates among political elites concerning Keynesian Economics, Classical Economics and Austerity. I have posted several articles from Wikipedia to give you the reader a clear definition of the three theories before I began my discussion concerning my views. Based on my limited understanding of basic college economics 101-102, I had to refresh my understanding of these theories before beginning my academic discussion. If you disagree or agree, please post comments on why you disagree or agree.
Let's start the discussion with the Greek Philosophy Socrates. Socrates believes that a wide range of discussions on a type of pedagogy in which a series of questions are asked would not only draw individual answers, but “encourage insight into the question at hand. In other words, we can increase our understanding and arrive at truth through debate, let the debate begin.
According to John Maynard Keynes, when private businesses make bad decisions that lead to “inefficient macroeconomic outcomes”, the state must then play a fundamental role to bring the economy out of crisis. Even though some might disagree with many of Karl Marx's economic theories, he accurately predicted that capitalist economies would go into crisis every 10 to 20 years. He based his theory on the idea that as more wealth is concentrated in the hand of a few people, workers would no longer be able to buy the goods they produce. Karl Marx's theory was seriously examined by many leading economist during the great depression around 1930. After the great depression, the government set-up the central bank and passed many anti-trust laws to prevent a major crisis. I would argue that some of Marx's tenets need to be re-examined because the US has never had a major crisis since 1930. I think that one might surmise that the reason why we have not had a crisis since 1930 had something to do with the development of a central bank. But since that is not the central theme of this essay, I will put that discussion aside for a later period.
Keynesian economics Keynesian economics is based on a mixed economic approach that involves private, public and government involvement to keep the economic from going into crisis. Since the financial crisis in 2008, demand-siders are starting to re-examine his theory. In my opinion President Obama and George Bush may not be Keynesian's, but both stimulus policies were based on Keynesian economics.
President Roosevelt was one of the first presidents to implement Keynesian policies during Great Depression in 1930. His program was called the New Deal. According to Wikipedia, “in his first hundred days in office, which began March 4, 1933, Roosevelt spearheaded major legislation and issued a profusion of executive orders that instituted the New Deal—a variety of programs designed to produce relief (government jobs for the unemployed), recovery (economic growth), and reform (through regulation of Wall Street, banks and transportation). The economy improved rapidly from 1933 to 1937, but then relapsed into a deep recession.”
Franklin Delano Roosevelt January 30, 1882 – April 12, 1945), also known by his initials, FDR, was the 32nd President of the United States (1933–1945)
During the Great Depression, Roosevelt did increase government spending to order to put people back to work. He radically re-organized the government under the New Deal and designed a variety of social government programs (mentioned above) which gave the federal government more control over the economy. Many supply-side economist in the Republican Party and those preaching free trade blamed Roosevelt for increasing the size of government. While it can be argue that Roosevelt did increase government programs, these programs have kept the economy from going into a depression over the last 60 years. One can develop a convincing argument based on economic history that Keynesian economic policies have kept the economy out of crisis.
George Bush and President Obama George Bush implemented Keynesian policies by pumping billions of dollars into major banks during the Economic Recession in 2008. When President Obama came into office, he continued the same policies but he demanded more accountability. Although one can develop a pervasive political argue for Obama decision, but looking at it from a pure economic argument standpoint, he made a series of bad decisions concerning the crisis in my opinion. When he came to the White House he allowed his economic advisers who were linked to Wall Street to continue giving bail out money to large banks. Once these large banks got the bail-outs, they used the money to buy out their competitors rather than loan the money to small firms that was hurt by the crisis. They raided the government treasury while small firms continue to go out of business and unemployment continued to climb. President Obama should have nationalized or put these large firms into receivership, this would have loosened up the credit markets and allowed small firms to keep their doors open. President Obama's stimulus program was not a complete failure because he demanded more accountability for paying back government loans. Firstly, the banks and financial institutions had to pay back the money with interest and secondly, they had to give the federal government shares in their institutions until the loans were re-paid. In summary, President Obama can strongly argue that his economic approach worked better than President Bush’s approach because he added around 8 millions jobs to the economy. The auto industry that was on the brink of collapsing is now hiring new workers and unemployment is now around 6.0%. If the economy continues to grow, (even at a slow pace) it might be around 5.0% by next year according to some economist. The government considers 4.0% as full employment under our system.
Classical Economics
Conservative economist argues that the reason why the economy went into recession in 2008 was because the government was spending too much money and imposing too many regulations on private business. They want less government spending, tax cuts and getting rid of government regulations which they claim hurt businesses. This approach is based what is called austerity and can also be referred to as the classical economic approach.
David Ricardo (18 April 1772 – 11 September 1823) was the first Englishman to advance the classical economic approach. Keynesian's were opposed to this approach. This approach was based on what became known as Say's Law. I will discuss more about the law later. The classical economist called for little or no government intervention in the economy. They believe that the law of supply and demand would eventually correct any economic ma-adjustments. They along with many conservative Republicans further surmised that after the 1930 crash, as stated above, there were no need for government involvement because the economy would have eventually recovered on it's own once the supply (overproduction of goods decreased), the demand for goods would put people back to work.
The neoclassical theory holds that two main cost influence supply and demand: labor and money. If there is too much labor, the price of labor will fall. If there is too much savings and not enough spending, then interest rates will fall. This approach might work if we are willing to let the economy go into a depression and wait until demand for goods and services put workers back to work. The truth is folks, no economist or government official is willing to risk such a drastic approach because it might bring about a revolution or mass social upheaval.
Supply and Demand "Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers (at current price) will equal the quantity supplied by producers (at current price), resulting in an economic equilibrium of price and quantity.
The two basic laws of supply and demand are:
• If demand increases and supply remains unchanged, then it leads to higher equilibrium price and higher quantity.
• If demand decreases and supply remains unchanged, then it leads to lower equilibrium price and lower quantity.
Wikipedia
Say’ Law
As discussed above, the central tenet of the classical view, known as Say's law, states that "supply creates its own demand, so Say's Law can be interpreted in two ways. First, the claim that the total value of output is equal to the sum of income earned in production is a result of a national income accounting identity, and is therefore indisputable. A second and stronger claim, however, that the "costs of output are always covered in the aggregate by the sale-proceeds resulting from demand" depends on how consumption and saving are linked to production and investment. In particular, Keynes argued against Say's Law by pointing out Say's Law only holds if increases in individual savings exactly match an increase in aggregate investment." Wikipedia
Demanding products requires the possession of money which is based on supply. Assets and or labor are used to produce money which creates demand. A person holding on to their money distorts the law because aggregate supply will not equal aggregate demand. When workers are unemployed, they hold on to their money and producers will not spend money if they cannot get a proper return. Since we do not spend all of the money that we have in our possession, the demand for current goods and services will not equal the value of what has been produced. If producers cannot get the price they demand, they will hold on to their money which in turn would create recession and economic crisis.
Keynes sought to develop a theory that would explain determinants of saving, consumption, investment and production. In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy.
Neoclassical economist argues that the two main costs that shift demand and supply are labor and money and distribution of the monetary policy. They argue these two things can be adjusted through demand and supply; if there were “more labor than demand for it, wages would fall until hiring began again. If there were too much saving, and not enough consumption, then interest rates would fall until people either cut their savings rate or started borrowing”.
Macroeconomist who are associated with the Keynesian school “advocate that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, particularly monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. The theories forming the basis of Keynesian economics were first presented in The General Theory of Employment, Interest and Money, published in 1936. The interpretations of Keynes are contentious and several schools of thought claim his legacy. As discussed above, Keynesian economics advocates a mixed economy which evolves private and public sections (which was mention above) playing and equal role in government, but the public sector plays the significant role. According to Wikipedia, this economic model has played a dominate role since the:
“later part of the Great Depression, World War II, and the post-war economic expansion (1945–1973), though it lost some influence following the tax surcharge in 1968 and the stagflation of the 1970s. The advent of the global financial crisis in 2008 has caused resurgence in Keynesian thought”.
Theory
According to Keynesian theory, some individually-rational microeconomic-level actions — if taken collectively by a large proportion of individuals and firms — can lead to inefficient aggregate macroeconomic outcomes, wherein the economy operates below its potential output and growth rate. Such a situation had previously been referred to by classical economists as a general glut. There was disagreement among classical economists on whether a general glut was possible. Keynes contended that a general glut would occur when aggregate demand for goods was insufficient, leading to an economic downturn. Losses of potential output due to unnecessarily high unemployment are the result. Producers then react defensively (or reactive) making decisions that damage macroeconomics.
Most Keynesian's advocate an active stabilization policy to reduce the amplitude of the business cycle, which they rank among the most serious of economic problems. Government policies can be used to increase aggregate demand, thus increasing economic activity, reducing unemployment and deflation. For example, when the unemployment rate is very high, a government can use a dose of expansionary monetary policy.
Keynesian’s argued that the solution to the Great Depression was to stimulate the economy ("inducement to invest") through some combination of two approaches: 1: A reduction in interest rates, and 2: government investment in infrastructure. Investment by government injects income, which results in more spending in the general economy. This in turn stimulates more production and investment involving still more income and spending and so forth. The initial stimulation starts a cascade of events, whose total increase in economic activity is a multiple of the original investment. Janet Yellen, the New Federal Reserve chairman has stated that she plans on keeping interest rates low for the foreseeable future because unemployment is still high and the housing market is still weak.
A central conclusion of Keynesian economics is that, in some situations, no strong automatic mechanism moves output and employment towards full employment levels. This conclusion conflicts with economic approaches that assume a strong general tendency towards equilibrium. In the 'neoclassical synthesis', which combines Keynesian macro concepts with a micro foundation, the conditions of general equilibrium allow for price adjustment to eventually achieve this goal. More broadly, Keynes saw his theory as a general theory, in which utilization of resources could be high or low, whereas previous economics focused on the particular case of full utilization.
The new classical macroeconomics movement, which began in the late 1960s and early 1970s, criticized Keynesian theories, while New Keynesian economics has sought to base Keynes' ideas on more rigorous theoretical foundations.
Some interpretations of Keynes have emphasized his stress on the international coordination of Keynesian policies, the need for international economic institutions, and the ways in which economic forces could lead to war or could promote peace.
Keynes sought to develop a theory that would explain determinants of saving, consumption, investment and production. In that theory, the interaction of aggregate demand and aggregate supply determines the level of output and employment in the economy.
Because of what he considered the failure of the “Classical Theory” in the 1930s, Keynes firmly objects to its main theory—adjustments in prices would automatically make demand tend to the full employment level.
Neo-classical theory supports that the two main costs that shift demand and supply are labor and money. Through the distribution of the monetary policy, demand and supply can be adjusted. If there were more labor than demand for it, wages would fall until hiring began again. If there were too much saving, and not enough consumption, then interest rates would fall until people either cut their savings rate or started borrowing.
Conclusion:
If Roosevelt had relied on this approach, he would have put our democracy in danger. Many conservative economists argued today that the economic would have eventually recovered with out the massive government spending and reforms, but at what cost. Karl Marx based his theory of revolution on his understanding of classical economics. What he could not have predicted (because of his time in history), is the role governments played during economic crisis. After 1930 depression, capitalist governments as stated above had developed many federal policies which were designed to delay major economic crisis. One can argue that some of these policies put capitalism on trial because they moved their governments away from the idea of pure capitalism and more toward a mixed economic.
Understanding Say's Law of Markets
Beware measures to boost aggregate demand.
JANUARY 01, 1997 by STEVEN HORWITZ
One of the problems in the world of ideas, particularly in the social sciences, is that the insight behind old ideas can get lost as new ideas crowd the intellectual landscape. Often, the historian of ideas has the thankless task of reminding his colleagues that what they think some long-dead writer said is not, in fact, what he was talking about at all.
Such misunderstandings are frequently more than just simple errors; they can have profound effects on our theories of the social world, our interpretations of history, and our proposals for policy. In economics, one can find numerous examples of this phenomenon. My task here is to explore one of them: the way in which Say’s Law of Markets (named for the great Classical economist Jean-Baptiste Say) has been fundamentally misunderstood by economic theorists and laypersons alike, and to explore some of the consequences of this misunderstanding.
W. H. Hutt once referred to Say’s Law as the most fundamental ‘economic law’ in all economic theory. In its crude and colloquial form, Say’s Law is frequently understood as supply creates its own demand, as if the simple act of supplying some good or service on the market was sufficient to call forth demand for that product. It is certainly true that producers can undertake expenses, such as advertising, to persuade people to purchase a good they have already chosen to supply, but that is not the same thing as saying that an act of supply necessarily creates demand for the good in question. This understanding of the law is obviously nonsensical as numerous business and product failures can attest to. If Say’s Law were true in this colloquial sense, then we could all get very rich just by producing whatever we wanted.
In a somewhat more sophisticated understanding, one which John Maynard Keynes appeared to pin on the Classical economists, Say’s Law is supposed to be saying that the aggregate supply of goods and services and the aggregate demand for goods and services will always be equal. In addition, Say was supposed to have been saying that this equality would occur at a point where all resources are fully employed. Thus, on this view, the Classical economists supposedly believed that markets always reached this full-employment equilibrium. In one sense this is trivially true. If we compare the actual (ex post) quantities of goods bought (demanded) and sold (supplied) they will always be equal. Whatever is sold by one person is bought by another. Presumably, however, Keynes thought the Classical economists meant something else, perhaps more along the lines of market economies will never create general gluts or shortages because the income generated by sales will always be sufficient to purchase the quantity of goods available to buy. There is a strong sense in which this is true, but by itself it does not assure that full employment will take place because obvious examples of significant unemployment and unsold goods can easily be pointed to. And, in fact, this is what critics of Say’s Law have done. By pointing to the various recessions and depressions that market economies have experienced, they claim to show that Say’s Law was at the very least naive, and probably downright wrong.
What Say Said
If we want to get a more accurate understanding of Say’s Law, perhaps we should consult what Say himself had to say about his supposed law. In the passage where he gets at the insight behind the notion that supply creates its own demand, Say writes: “it is production which opens a demand for products. . . . Thus the mere circumstance of the creation of one product immediately opens a vent for other products.” Put another way, Say was making the claim that production is the source of demand. One’s ability to demand goods and services from others derives from the income produced by one’s own acts of production. Wealth is created by production not by consumption. My ability to demand food, clothing, and shelter derives from the productivity of my labor or my non-labor assets. The higher (lower) that productivity, the higher (lower) is my power to demand.
In his excellent book on Say’s Law, Hutt states this as: “All power to demand is derived from production and supply. . . . The process of supplying—i.e., the production and appropriate pricing of services or assets for replacement or growth—keeps the flow of demands flowing steadily or expanding.” Later, Hutt was to be somewhat more precise with his definition: “the demand for any commodity is a function of the supply of noncompeting commodities.” The addition of the modifier noncompeting is important. If I sell my services as a computer technician, it is presumed that my resulting demands will be for goods and for services other than those of a computer technician (or something similar). The goods or services competing with those that I sell can always be obtained by applying my labor directly, so I am unlikely to demand them. The demand for my services as a computer technician is a result of the supplying activities of everyone but computer technicians.
This way of viewing Say’s Law gets at the interconnections between the various sectors of a market economy. In particular, it makes sense of the claim that the employment of all is the employment of each. As each worker finds employment, he or she is able to turn around and demand goods and services from all other noncompeting suppliers, creating the opportunity for their employment. From this perspective, Say’s Law has nothing to do with an equilibrium between aggregate supply and aggregate demand, but rather it describes the process by which supplies in general are turned into demands in general. It is always the level of production which determines the ability to demand.
Production Must Come First
This process can be seen in the differences between small, poor, rural towns and wealthier suburban areas. In the small town, the fact that less value is being produced by residents means that their ability to demand goods and services is correspondingly limited. As a result, the selection of products, the number and diversity of sellers, and the degree of specialization among producers is quite limited. By contrast, in the wealthier suburb, there is an amazing array of products, with a large number of diverse sellers all offering very specialized goods. Perhaps most important is that in the wealthier area, there is a greater degree of competition, as the market can support multiple sellers of particular goods given the level of wealth being generated by producers. Say points out that this explains why a seller will likely get more business as one among a large number of competitors in a big city than the sole seller of an item in the more sparsely populated countryside. The key to understanding Say’s Law of Markets is that it is production that must come first. Demand, or consumption, follows from the production of wealth.
To a degree, Say’s Law is just an extension of Adam Smith’s insight that the division of labor is limited by the extent of the market. Smith’s point was that the degree of specialization that one would see in a given market depended upon how much demand there was for the specialized product. Thus, small towns rarely have ethnic restaurants beyond the very popular Chinese and Italian, nor do they have radio stations that specialize in very narrow musical formats (oldies from the 1970s only, for example). Larger, wealthier communities can support this degree of specialization because there is sufficient demand, deriving from a larger population and a larger degree of wealth being produced. It is in this sense that production (supply) is the source of demand.
Because all movements between supplying and demanding have to take place through the medium of money, it is somewhat oversimplified to say that production is the source of demand. Actually demanding products requires the possession of money, which in turn requires a previous act of supply. We sell assets or labor services for money, which we then use to demand. Money is an intermediate good that enables us to buy the things we ultimately desire. However, we have to be careful to remember that what enables us to purchase is not the possession of money, per Se, but the possession of productive assets that can fetch a money’s worth on the market. When we sell that asset (or our labor services) we receive wealth in the form of money. As we spend that money, we demand from the wealth our production created. However, because we do not spend all of our wealth that we temporarily store as money, but choose to continue to hold some of it in the monetary form, the demand for current goods and services will not precisely match the value of what has been produced, as some money remains in the producers’ possession. Thus it looks as though, given the existence and use of money, Say’s Law, even rightly understood, leaves open the possibility that aggregate demand is insufficient to purchase what has been supplied.
However, if the monetary wealth is stored in the form of bank-created money, such as a checking account (but not Federal Reserve Notes), then that withheld consumption power will be transferred to those who borrow money from the bank that created it. The money I leave sitting in my checking account is the basis for my bank’s ability to lend to others. The power to consume that I choose not to utilize by leaving my production-generated wealth as money is transferred to the borrower. When she spends her loan, her addition to aggregate demand fills in for the missing consumption demand resulting from my decision to hold money. There is, therefore, no excess or deficiency in aggregate demand, as long as the banking system is free to perform this process of turning the saving of depositors into the spending of borrowers. Say’s Law of Markets cannot be fully appreciated unless one understands the working of the banking system and its role in intertemporal coordination.
(Intertemporal is the process by which people make decisions about what and how much to do at various points in time, when choices at one time influence the possibilities available at other points in time)
All Markets Are Money Markets
Because all market exchanges are of goods or services for money, all markets are money markets, and the only way there can be an excess supply or demand for goods is if there is an opposite excess supply or demand for money. Take the more obvious case of a glut of goods, such as one might find in a recession. Say’s Law, properly understood, suggests that the explanation for an excess supply of goods is an excess demand for money. Goods are going unsold because buyers cannot get their hands on the money they need to buy them despite being potentially productive suppliers of labor. Conversely, a general shortage, or excess demand for goods, can only arise if there is an excess supply of the thing goods trade against, which can only be money. Recessions and inflation's are, therefore, fundamentally monetary phenomena, as Say’s Law points us in the direction of looking at what is going on in the production of money to explain the breakdown of the translation process of production into demand.
Unlike Keynesian critics of Say’s Law of Markets who saw deficient aggregate demand resulting from various forms of market failure as causing economic downturns, we have argued that a more accurate understanding of Say’s Law suggests that there is no inherent flaw in the market that leads to deficient aggregate demand, nor is the existence of real-world recessions a refutation of the Law. Rather, once we understand the role of money in making possible the translation of our productive powers of supply into the ability to demand from other producers, we can see that the root of macroeconomic disorder is most likely monetary, as too much or too little money will undermine that translation process. Despite having been dismissed in the onslaught of the Keynesian revolution, Say’s Law, when properly understood both in its original meaning and its relationship to the banking system, remains a powerful insight into the operations of a market economy.
Sources:
STEVEN HORWITZ
Understanding Say's Law of Markets
Beware measures to boost aggregate demand.
JANUARY 01, 1997
http://www.fee.org/
…/det…/understanding-says-law-of-markets/ Wikipedia: Say's Law
http://en.wikipedia.org/wiki/Say%27s_law
Robert B. Reich
"Aftershock", The Nest Economy & American's Future
Karl Marx
Das Capital
Say's Law Of Markets
http://www.investopedia.com/terms/s/says-law.asp
