Economic Populist Commentary

Economic commentary by a pro-capitalist, economic populist. Demand-Side Economic theory. Consists of author's economic views. Questions & comments appreciated. Dissenting views are VERY welcome and encouraged. Main "agenda" is crafting and advocacy of a "populist" economic agenda. A secondary goal is prevention of an economic Armageddon. Encouraging open discussion of US economy.

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The author is a physician by profession, and a "student economist" by necessity. The current status of our economy necessitates the latter. The intent of this blog is to explain and discuss economics in layman terms. It is designed to promote thought and discussion. It is written by a layman. Comments and critiques of these theories and letters are welcome and ENCOURAGED. Dissenting comments are also WELCOME! They form the basis for discussion.

Friday, August 05, 2005







THE MIS- INTERPRETATION OF KEYNES

Keynesian economics has been criticized for its advocacy of government spending to prop up AGGREGATE DEMAND. But it is a mistake to define Keynesian economic theory simply as advocacy of increased government spending. This was a very limited part of his theory.
Keynes' greatest contribution to economic thinking was his recognition of the importance of AGGREGATE DEMAND. Keynes correctly identified aggregate demand as THE most important factor in economic activity. Keynes explained why aggregate demand was the major driving force of an economy. With no aggregate demand, there is no production or industrial output. Low aggregate demand results in low production and industrial output.

Keynes advocated increasing aggregate demand through increased government spending if it was insufficient to drive industrial output. This could be done through government deficit spending. This was NEVER intended to be anything but a short-term fix. This temporary fix was designed to put labor back to work, thus increasing labor/consumer income, as well as the increased consumer demand that would follow. The desired end result was to put labor and production facilities back to work, returning them to their wealth-creating function.
No production or wealth is created when workers and production facilities sit idle. By temporarily increasing aggregate demand, those facilities would be restored to their wealth-creating function. With the newly increased aggregate labor/consumer income, and the increased consumer demand that resulted, a self-perpetuating cycle would be initiated. The increase in consumer income and production demand would cause FURTHER increases in demand for workers to provide that production. As a result, more workers would be hired and aggregate labor/consumer income would increase still further. Again, this would further increase consumer spending and demand, causing even further hiring of workers to provide the increased demand. Though not specifically stated by Keynes, but of equal importance, the ever increasing demand for labor would increase wages as well. This would even further increase the AGGREGATE DEMAND that Keynes was trying to prop up.

Keynesian government "pump-priming" efforts were less successful initially than would have been predicted. There were 2 general reasons for this. The 1st related to the magnitude of "pump-priming" necessary. The other related to consumer behavior.

The biggest reason for the suboptimal result of Keynesian aggregate demand infusion was that it was not large enough. The pre-World War II government spending increases that Roosevelt put in place were simply not enough to adequately jump-start the economy. Inadvertently, it was the much larger increase in government spending caused by World War II that successfully jump-started the economy. The massive government spending that entailed increased AGGREGATE DEMAND enough to get the economy rolling again, and end the Great Depression. Keynes was proven right about the necessity of aggregate demand, and that increasing it would restore the economy to normal. But no one knew how much was necessary until the onset of World War II.

The 2nd reason Keynes' ideas were not initially successful was due to consumer behavior. The limited increases aggregate consumer income did not have the magnitude of effect on consumer spending that was anticipated. After years of low income and poverty, Americans were less likely to spend their increased income than they would have been today. They held on to much of their increased income, instead of spending it. Consumers were uncertain as to what the future might bring. The less than predicted consumer spending caused a less than predicted increase in consumer production demand, and aggregate demand as a whole. The suboptimal production demand increase caused a suboptimal demand for labor to provide that production.

The Depression had caused consumers to semi-permanently lower their spending habits. Again, the result was consumer spending & demand lagged behind consumer income. One might say there was a pronounced lack of "consumer confidence." This understandable lack of confidence fed back on itself, however, causing aggregate demand to be insufficient to resurrect the economy. Again, it took the massive increase in production demand, employment, and consumer income caused by World War II to break the cycle.

Keynes never envisioned increased government spending as a PERMANENT solution to an aggregate demand deficiency. It was to be a TEMPORARY solution only. Once the economy was doing well the debt was to be paid down. The fact that it wasn't has nothing to do with Keynes, or his theories.

Many who discredit Keynes are fully aware of this point, but claim otherwise. They attempt to dismiss Keynes as simply an advocate of "big government." Again, his critics are being dishonest with this claim. Their true dislike of Keynes has nothing to do with Keynes' alleged advocacy of big government or government spending.

The REAL motivation is Keynes' recognition of the importance of AGGREGATE DEMAND. Acknowledgment of this importance discredits many popular, yet illogical, economic beliefs. It refutes the completely illogical notion that "investment creates jobs." It refutes many tenants of classical economics, as well as monetarism and supply-side theories.

In general, acknowledgment of AGGREGATE DEMAND's significance refutes the beliefs that "trickle-down" economics, or "priming the pump" from the top, is of any benefit. In a more practical sense, it refutes the benefits of high-end tax cuts, corporate tax cuts, and labor cost reduction through outsourcing. In fact, Keynes showed that anything that was bad for the consumer was bad for business, as well as labor and the overall economy in the long run. Keynes demonstrated that reduced aggregate demand would hurt the economy, regardless of how much investment capital was available. He showed clearly that it is DEMAND that creates jobs, not investment. The Great Depression proved him right.

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