Macro Theory:Macro Theory:

Dr. D. Foster – ECO 285 – Spring 2014

Will Say’s Law Trump the Will Say’s Law Trump the Keynesian Revolution?Keynesian Revolution?

Extreme Version of Keynesian TheoryExtreme Version of Keynesian Theory

AD1

P

Q or R-GDP

Wages & Prices are Wages & Prices are perfectly inflexible when perfectly inflexible when AD falls.AD falls.

A lack of “animal spirits” A lack of “animal spirits” results in a fall in AD, results in a fall in AD, overproduction and a overproduction and a sharp recession.sharp recession.

AS may never correct for AS may never correct for this problem and the this problem and the economy comes to rest economy comes to rest with an “unemployment with an “unemployment equilibrium.”equilibrium.”

Solution is to raise AD by Solution is to raise AD by G (or G (or T or T or TP).TP).

ASLR

Q*Q1

AD2

It violates Say’s Law:

““One’s ability to demand goods and services One’s ability to demand goods and services from others derives from the income produced from others derives from the income produced

by one’s own acts of production. Wealth is by one’s own acts of production. Wealth is created by production not by consumption.”created by production not by consumption.”

So, What’s Wrong with this So, What’s Wrong with this Story?Story?

There can’t be a glutcan’t be a glut of all goods!

Recessions show that we are producing the wrong mix of goods (producer errorproducer error).

Prices cancan clear all markets! Note: Say’s Law is not supply

creates its own demand.

Say’s Law – Simple VersionSay’s Law – Simple Version

Goods are only supplied because they are Goods are only supplied because they are demanded!!!demanded!!!

Say’s Law in ActionSay’s Law in Action

Supply

Demand

Say’s Law – From Beginning to End of the ProcessSay’s Law – From Beginning to End of the Process

I want something!

To get it, I must produce something of value to others!

So, I produce something.

I sell this in the market for money.

I take the money and buy the stuff I want.

End of story.

Repeat over and over and over and …

What Keynes Says.What Keynes Says.

We are making too much stuff; of everything!(But, how is that possible? We do live in a world of scarcity!)

It must be that people don’t have enough money to buy all this stuff!(As opposed to the idea that we are making the wrong stuff!)

So, let’s just give people money!(Even if it is just to dig holes and fill them back in again.)

This will restore full employment.(And, we’ll still be producing the wrong stuff!)

End of story.

No! We must repeat over and over and over …

ARRA of 2009 - $800 billionBudget deficits 5% - 10% of GDP2009-20132009-2013 = $6 tr. = 35% of GDP

Unemployment rate = 6.6%(Or, higher if others included and calculations constant.)

GDP growth sluggish.2%-3% since 2009; 2013 Q4 rev. to 2.4%.

And, the Fed is still money.Our next story, after the exam.

The promise of Keynesian Theory: Business Cycles are History!Business Cycles are History!

Has Keynesian Policy Worked?

Is the economy really even growing at all?

What’s the Deal with Saving?

Keynes:Keynes:** It has a negative effect on the economy. (Contemporary Keynesians don’t hold this extreme view.)** It isn’t necessarily channeled into investment.** What we need is more spending, not more saving. (Contemporary Keynesians do hold this view.)

Say:Say:** You can’t have economic growth w/out capital.** You can’t have capital without investment.** You can’t have investment without saving.** Because of producer error we need to re-direct resources.** To encourage capital formation, we need more saving.** There is automatic adjustment during recession – more saving will lead to more production.

Who saves more – households or businesses?Who saves more – households or businesses?

Business

HH

Gross private, net private & net gov’t saving.Gross private, net private & net gov’t saving.

TotalPrivat

e

Gov’t

Net savings as a percent of GDP.Net savings as a percent of GDP.

Personal Saving Rate; 1960 - 2013Personal Saving Rate; 1960 - 2013

What about the Great Depression/Recession?

Keynes:Given severity of unemployment, proves overproduction cause.Collapse of investment proves saving is futile.Given length, proves that adjustment isn’t automatic.Tepid improvement indicates that more needed to be done.Rapid “improvement” during/after WWII proves prescription.

Say/Higgs:That markets can’t clear is sign of government intervention.Existence of unions & gov’t price fixing policies worsen outcome.Long run economic health = f(saving, investment, capital)Collapse of investment is due to “regime uncertainty.” ** It’s not negative changes, but uncertain changes! ** 2012 – fed’l regulators 35% since 2006, >300 tax provisions expired in last 5 years…

Macro Theory:Macro Theory:

Dr. D. Foster – ECO 285 – Spring 2014

Will Say’s Law Trump the Will Say’s Law Trump the Keynesian Revolution?Keynesian Revolution?